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Elements  of  Foreign 
Exchange 

A  FOREIGN  EXCHANGE  PRIMER 

By  FRANKLIN  ESCHER 

.Special    Lecturer   on   Foreign   Exchange    at    New 
York   University 


Eighth  Edition 


NEW  YORK 
THE  BANKERS  PUBLISHING  COMPANY 

1918 


3*378 


Copyright  1910 

By  the  Bankers  Publishing  Co. 

New  York 


3S2| 


CONTENTS 


PAGE 

Chapter  I.     What  Foreign  Exchange  is 
and  What  Brings  it  into  Existence  . .     3 

The  various  forms  of  obligation  between  the 
bankers  and  merchants  of  one  country  and  the 
bankers  and  merchants  of  another,  which  result 
in  the  drawing  of  bills  of  exchange. 

Chapter  II.     The  Demand  for  Bills  of 
Exchange   15 

A  discussion  of  the  six  sources  from  which  spring 
the  demand  for  the  various  kinds  of  bills  of 
exchange. 

Chapter   III.     The   Rise   and   Fall   of 
Exchange  Rates 25 

Operation  of  the  five  main  influences  tending  to 
make  exchange  rise  as  opposed  to  the  five  main 
influences  tending  to  make  exchange  fall. 

Chapter    IV.     The    Various    Kinds    of 
Exchange   45 

A  detailed  description  of:  Commercial  "Long" 
Bills— Clean  Bills — Commercial  "Short"  Bills 
— Drafts  drawn  against  securities  sold  abroad 
— Bankers'  demand  drafts — Bankers'  "long" 
drafts. 

ill 


Chapter  V.  The  Foreign  Exchange 
Market   .59 

How  the  exchange  market  is  constituted.  The 
bankers,  dealers  and  brokers  who  make  it  up. 
How  exchange  rates  are  established.  The 
relative  importance  of  different  kinds  of 
exchange. 

Chapter  VI.  How  Money  Is  Made  in 
Foreign  Exchange.  The  Operations 
of  the  Foreign  Department 68 

An  intimate  description  of:  Selling  demand  bills 
against  remittances  of  demand  bills — Selling 
cables  against  remittances  of  demand  bills — 
Selling  demand  drafts  against  remittances  of 
"long"  exchange — The  operation  of  lending 
foreign  money  here — The  drawing  of  finance 
bills — Arbitraging  in  Foreign  Exchange — 
Dealing  in  exchange  "futures." 

Chapter  VII.  Gold  Exports  and  Im- 
ports    106 

The  primary  movement  of  gold  from  the  mines  to 
the  markets,  and  its  subsequent  distribution 
along  the  lines  of  favorable  exchange  rates. 
Description  (with  presentation  of  actual  fig- 
ures) of:  The  export  of  gold  bars  from  New 
York  to  London — Import  of  gold  bars  from 
London — Export  of  gold  bars  to  Paris  under 
the  "triangular  operation."  Shipments  to 
Argentina. 

London  as  a  "free"  gold  market  and  the  ability  of 
the  Central  Banks  in  Europe  to  control  the 
movement  of  gold. 

lv 


Chapter  VIII.  Foreign  Exchange  in 
its  Relation  to  International  Secu- 
rity Trading   130 

Europe's  "fixed"  and  "floating"  investment  in 
American  bonds  and  stocks  a  constant  source  of 
international  security  trading.  Consequent  for- 
eign exchange  business.  Financing  foreign 
speculation  in  "Americans."  Description  of  the 
various  kinds  of  bond  and  stock  "arbitrage." 

Chapter  IX.  The  Financing  of  Ex- 
ports and  Imports 141 

A  complete  description  of  the  international  bank- 
ing system  by  which  merchandise  is  imported 
into  and  exported  from  the  United  States.  An 
actual  operation  followed  through  its  successive 
steps. 


xKKFACE 

"A]VHERE  can  I  find  a  little  book  from 

T  T        which  I  can  get  a  clear  idea  of  how 
foreign  exchange  works,  without  go- 
ing too  deeply  into  it?" — that  question,  put  to  the 
author  dozens  of  times  and  by  many  different 
kinds  of  people,  is  responsible  for  the  existence  of 
this  little  work.   There  are  one  or  two  well-writ- 
ten textbooks  on  foreign  exchange,  but  never  yet 
»      has  the  author  come  across  a  book  which  covered 
*l     this  subject  in  such  a  way  that  the  man  who  knew 
|     little  or  nothing  about  it  could  pick  up  the  book 
and  within  a  few  hours  get  a  clear  idea  of  how 

*  foreign  exchange  works, — the  causes  which  bear 
w  upon  its  movement,  its  influence  on  the  money 
V     and  security  markets,  etc. 

That  is  the  object  of  this  little  book — to  cover 

*  the  ground  of  foreign  exchange,  but  in  such  a  way 
to  as  to  make  the  subject  interesting  and  its  treat- 
ment readable  and  comprehensible  to  the  man 
without  technical  knowledge.  Foreign  exchange 
is  no  easy  subject  to  understand;  there  are  few 
important  subjects  which  are.  But,  on  the  other 
hand,  neither  is  it  the  complicated  and  abstruse 
subject  which  so  many  people  seem  to  consider  it 


— an  idea  only  too  often  born  of  a  look  into  some 
of  the  textbooks  on  exchange,  with  their  formid- 
able pages  of  tabulations,  formulas,  and  calcula- 
tions of  all  descriptions.  For  the  average  man 
there  is  little  of  interest  in  these  intricacies  of  the 
subject.  Many  of  the  shrewdest  and  most  suc- 
cessful exchange  bankers  in  New  York  City,  in- 
deed, know  less  about  them  than  do  some  of  their 
clerks.  What  is  needed  is  rather  a  clear  and 
definite  knowledge  of  the  movement  of  exchange 
— why  it  moves  as  it  does,  what  can  be  read  from 
its  movements,  what  effects  its  movements  exert 
on  the  other  markets.  It  is  in  the  hope  that  some- 
thing may  be  added  to  the  general  understanding 
of  these  important  matters  that  this  little  book 
is  offered  to  the  public. 


THE    ELEMENTS    OF    FOREIGN 
EXCHANGE 


CHAPTER    I 

WHAT     FOREIGN     EXCHANGE      IS 

AND  WHAT  BRINGS  IT  INTO 

EXISTENCE 

UNDERLYING  the  whole  business  of  for- 
eign exchange  is  the  way  in  which  obliga- 
tions between  creditors  in  one  country 
and  debtors  in  another  have  come  to  be  settled — 
by  having  the  creditor  draw  a  draft  directly  upon 
the  debtor  or  upon  some  bank  designated  by  him. 
A  merchant  in  New  York  has  sold  a  bill  of  goods 
to  a  merchant  in  London,  having  thus  become  his 
creditor,  say,  for  $5,000.  To  get  his  money,  the 
merchant  in  New  York  will,  in  the  great  majority 
of  cases,  draw  a  sterling  draft  upon  the  debtor  in 
London  for  a  little  over  £1,000.  This  draft  his 
banker  will  readily  enough  convert  for  him  into 
dollars.  The  buying  and  selling  and  discounting 
of  countless  such  bills  of  exchange  constitute  the 
very  foundation  of  the  foreign  exchange  business. 
Not  all  international  obligations  are  settled  by 
having  the  creditor  draw  direct  on  the  debtor. 
Sometimes  gold  is  actually  sent  in  payment. 
Sometimes  the  debtor  goes  to  a  banker  engaged 
in  selling  drafts  on  the  city  where  the  obligation 


4  FOREIGN    EXCHANGE 

exists,  gets  such  a  draft  from  him  and  sends  that. 
But  in  the  vast  majority  of  cases  payment  is  ef- 
fected as  stated — by  a  draft  drawn  directly  on 
the  buyer  of  the  goods.  John  Smith  in  London 
owes  me  money.  I  draw  on  him  for  £100,  take 
the  draft  around  to  my  bank  and  sell  it  at,  say, 
4.86,  getting  for  it  a  check  for  $486.00.  I  have 
my  money,  and  I  am  out  of  the  transaction. 

Obligations  continually  arising  in  the  course 
of  trade  and  finance  between  firms  in  New  York 
and  firms  in  London,  it  follows  that  every  day  in 
New  York  there  will  be  merchants  with  sterling 
drafts  on  London  which  they  are  anxious  to  sell 
for  dollars,  and  vice  versa.  The  supply  of  ex- 
change, therefore,  varies  with  the  obligations  of 
one  country  to  another.  If  merchants  in  New 
York,  for  instance,  have  sold  goods  in  quantity  in 
London,  a  great  many  drafts  on  London  will  be 
drawn  and  offered  for  sale  in  the  New  York  ex- 
change market.  The  supply,  it  will  of  course  be 
apparent,  varies.  Sometimes  there  are  many 
drafts  for  sale;  sometimes  very  few.  When  there 
are  a  great  many  drafts  offering,  their  makers 
will  naturally  have  to  accept  a  lower  rate  of  ex- 
change than  when  the  supply  is  light. 

The  par  of  exchange  between  any  two  coun- 
tries is  the  price  of  the  gold  unit  of  one  expressed 


FOREIGN    EXCHANGE  5 

in  the  money  of  the  other.  Take  England  and 
the  United  States.  The  gold  unit  of  England  is 
the  pound  sterling.  What  is  the  price  of  as  much 
gold  as  there  is  in  a  new  pound  sterling,  expressed 
in  American  money?  $4.8665.  That  amount  of 
dollars  and  cents  at  any  United  States  assay  office 
will  buy  exactly  as  much  gold  as  there  is  con- 
tained in  a  new  British  pound  sterling,  or  sov- 
ereign, as  the  actual  coin  itself  is  called.  4.8665  is 
the  mint  par  of  exchange  between  Great  Britain 
and  the  United  States. 

The  fact  that  the  gold  in  a  new  British  sov- 
ereign (or  pound  sterling)  is  worth  $4.8665  in 
our  money  by  no  means  proves,  however,  that 
drafts  payable  in  pounds  in  London  can  always 
be  bought  or  sold  for  $4.8665  per  pound.  To  re- 
duce the  case  to  a  unit  basis,  suppose  that  you 
owed  one  pound  in  London,  and  that,  finding  it 
difficult  to  buy  a  draft  to  send  in  payment,  you 
elected  to  send  actual  gold.  The  amount  of  gold 
necessary  to  settle  your  debt  would  cost  $4.8665, 
in  addition  to  which  you  would  have  to  pay  all 
the  expenses  of  remitting.  It  would  be  cheaper, 
therefore,  to  pay  considerably  more  than  $4.8665 
for  a  one-pound  draft,  and  you  would  probably 
bid  up  until  somebody  consented  to  sell  you  the 
draft  you  wanted. 


6  FOREIGN    EXCHANGE 

Which  goes  to  show  that  the  mint  par  is  not 
what  governs  the  price  at  which  drafts  in  pounds 
sterling  can  be  bought,  but  that  demand  and 
supply  are  the  controlling  factors.  There  are 
exporters  who  have  been  shipping  merchandise 
and  selling  foreign  exchange  against  the  ship- 
ments all  their  lives  who  have  never  even  heard  of 
a  mint  par  of  exchange.  All  they  know  is,  that 
when  exports  are  running  large  and  bills  in  great 
quantity  are  being  offered,  bankers  are  willing  to 
pay  them  only  low  rates — $4.83  or  $4.84,  perhaps, 
for  the  commercial  bills  they  want  to  sell'for  dol- 
lars. Conversely,  when  exports  are  running 
light  and  bills  drawn  against  shipments  are  scarce, 
bankers  may  be  willing  to  pay  4.87  or  4.88  for 
them. 

For  a  clear  understanding  of  the  mechanics  of 
the  exchange  market  there  is  necessary  a  clear 
understanding  of  what  the  various  forms  of  obli- 
gations are  which  bring  foreign  exchange  into 
existence.  Practically  all  bills  originate  from 
one  of  the  following  causes : 

1.  Merchandise  has  been  shipped  and  the  shipper  draws 
his  draft  on  the  buyer  or  on  a  bank  abroad  designated  by 
him. 

2.  Securities  have  been  sold  abroad  and  the  seller  is 
drawing  on  the  buyer  for  the  purchase  price. 


'I    I 


FOREIGN    EXCHANGE  7 

3.  Foreign  money  is  being  loaned  in  this  market,  the  op- 
eration necessitating  the  drawing  of  drafts  on  the  lender. 

4.  Finance-bills  are  being  drawn,  i.  e.,  a  banker  abroad 
is  allowing  a  banker  here  to  draw  on  him  in  pounds  sterling 
at  60  or  90  days'  sight  in  order  that  the  drawer  of  the  drafts 
may  sell  them  (for  dollars)  and  use  the  proceeds  until  the 
drafts  come  due  and  have  to  be  paid. 

1.  Looking  at  these  sources  of  supply  in  the 
order  in  which  they  are  given,  it  is  apparent,  first, 
what  a  vast  amount  of  foreign  exchange  origi- 
nates from  the  direct  export  of  merchandise  from 
this  country.  Exports  for  the  period  given  be- 
low have  been  as  follows: 

1913  $2,465,884,000 

1912  2,204,322,000 

1911  2,049,320,000 

1910  1,744,984,000 

1909  1,663,011,000 

Not  all  of  this  merchandise  is  drawn  against; 
in  some  cases  the  buyer  abroad  chooses  rather  to 
secure  a  dollar  draft  on  some  American  bank  and 
to  send  that  in  payment.  But  in  the  vast  ma- 
jority of  cases  the  regular  course  is  followed  and 
the  seller  here  draws  on  the  buyer  there. 

There  are  times,  therefore,  when  exchange 
originating  from  this  source  is  much  more  plenti- 
ful than  at  others.     During  the  last  quarter  of 


8  FOREIGN    EXCHANGE 

each  year,  for  instance,  when  the  cereal  and 
cotton  crop  exports  are  at  their  height,  exchange 
comes  flooding  into  the  New  York  market  from 
all  over  the  country,  literally  by  the  hundreds  of 
millions  of  dollars.  The  natural  effect  is  to  de- 
press rates — sometimes  to  a  point  where  it  be- 
comes possible  to  use  the  cheaply  obtainable 
exchange  to  buy  gold  on  the  other  side. 

In  a  following  chapter  a  more  detailed  descrip- 
tion of  the  New  York  exchange  market  is  given, 
but  in  passing,  it  is  well  to  note  how  the  whole 
country's  supply  of  commercial  exchange,  with 
certain  exceptions,  is  focussed  on  New  York. 
Chicago,  Philadelphia,  and  one  or  two  other  large 
cities  carry  on  a  pretty  large  business  in  ex- 
change, independent  of  New  York,  but  by  far 
the  greater  part  of  the  commercial  exchange 
originating  throughout  the  country  finds  its  way 
to  the  metropolis.  For  in  New  York  are  situ- 
ated so  many  banks  and  bankers  dealing  in  bills 
of  exchange  that  a  close  market  is  always  assured. 
The  cotton  exporter  in  Memphis  can  send  the 
bills  he  has  drawn  on  London  or  Liverpool  to  his 
broker  in  New  York  with  the  fullest  assurance 
that  they  will  be  sold  to  the  bankers  at  the  high- 
est possible  rate  of  exchange  anywhere  obtain- 
able. 


FOREIGN    EXCHANGE  9 

2.  The  second  source  of  supply  is  in  the  sale 
abroad  of  stocks  and  bonds.  Here  again  it  will 
be  evident  how  the  supply  of  bills  must  vary. 
There  are  times  when  heavy  flotations  of  bonds 
are  being  made  here  with  Europe  participating 
largely,  at  which  times  the  exchange  drawn 
against  the  securities  placed  abroad  mounts  up 
enormously  in  volume.  Then  again  there  are 
times  when  London  and  Paris  and  Berlin  buy 
heavily  into  our  listed  shares  and  when  every 
mail  finds  the  stock  exchange  houses  here  draw- 
ing millions  of  pounds,  marks,  and  francs  upon 
their  correspondents  abroad.  At  such  times  the 
supply  of  bills  is  apt  to  become  very  great. 

Origin  of  bills  from  this  source,  too,  is  apt  to 
exert  an  important  influence  on  rates,  in  that  it 
is  often  sudden  and  often  concentrated  on  a  com- 
paratively short  period  of  time.  The  announce- 
ment of  a  single  big  bond  issue,  often,  where  it  is 
an  assured  fact  that  a  large  part  of  it  will  be 
placed  abroad,  is  enough  to  seriously  depress  the 
exchange  market.  Bankers  know  that  when  the 
shipping  abroad  of  the  bonds  begins,  large 
amounts  of  bills  drawn  against  them  will  be  of- 
fered and  that  rates  will  in  all  probability  be 
driven  down. 

Announcements  of  such  issues,  as  well  as  an- 


10  FOREIGN    EXCHANGE 

nouncements  that  a  block  of  this  or  that  kind  of 
bonds  has  been  placed  abroad  with  some  foreign 
syndicate,  are  apt  to  come  suddenly  and  often 
find  the  exchange  market  unprepared.  For  the 
supply  of  exchange  originated  thereby,  it  must 
be  remembered,  is  not  confined  to  the  amount 
actually  drawn  against  bonds  sold  but  includes 
also  all  the  exchange  which  other  bankers,  in  their 
anticipation  of  lower  rates,  hasten  to  draw.  The 
exchange  market  is,  indeed,  a  sensitive  barometer, 
from  which  those  who  understand  it  can  read  all 
sorts  of  coming  developments.  It  often  happens 
that  buying  or  selling  movements  in  our  securi- 
ties by  the  foreigners  are  so  clearly  forecasted  by 
the  action  of  the  exchange  market  that  bankers 
here  are  able  to  gain  great  advantage  from  what 
they  are  able  to  foresee. 

3.  The  third  great  source  of  supply  is  in  the 
drafts  which  bankers  in  one  country  draw  upon 
bankers  in  another  in  the  operation  of  making 
international  loans.  The  mechanism  of  such 
transactions  will  be  treated  in  greater  detail  later 
on,  but  without  any  knowledge  of  the  subject 
whatever,  it  is  plain  that  the  transfer  of  banking 
capital,  say  from  England  to  the  United  States, 
can  best  be  effected  by  having  the  American 
house  draw  upon  the  English  bank  which  wants 


FOREIGN    EXCHANGE  11 

to  lend  the  money.  In  the  finely  adjusted  state 
of  the  foreign  exchanges  nowadays,  loans  are 
continually  being  made  by  bankers  in  one  coun- 
try to  bankers  and  merchants  in  another.  Very 
little  of  the  capital  so  transferred  goes  in  the 
form  of  gold.  A  London  house  decides  to  loan, 
say,  $100,000  in  the  American  market.  The 
terms  having  been  arranged,  the  London  house 
cables  its  New  York  correspondent  to  draw  for 
£20,000,  at  60  or  90  days'  sight,  as  the  case  may 
be.  The  New  York  house,  having  drawn  the 
draft,  sells  it  in  the  exchange  market,  realizing  on 
it  the  $100,000,  which  it  then  proceeds  to  loan  out 
according  to  instructions. 

The  arranging  of  these  loans,  it  will  be  seen, 
means  the  continuous  creation  of  very  large 
amounts  of  foreign  exchange.  As  the  financial 
relationships  between  our  bankers  and  those  of 
the  Old  World  have  been  developed,  it  has  come 
about  that  European  money  is  being  put  out  in 
this  market  in  increasing  volume.  Conditions  of 
money,  discount,  and  exchange  are  constantly 
being  watched  for  the  opportunity  to  make  loans 
on  favorable  terms,  and  the  aggregate  of  foreign 
money  loaned  out  here  at  times  reaches  very  large 
figures.  In  1901  Europe  had  big  amounts  of 
money  outstanding  in  the  New  York  market,  and 


12  FOREIGN    EXCHANGE 

again  in  1906  very  large  sums  of  English  and 
French  capital  were  temporarily  placed  at  our 
disposal.  But  in  the  summer  of  1909  all  records 
were  surpassed,  American  borrowings  in  London 
and  Paris  footing  up  to  at  least  half  a  billion 
dollars.  Such  loans,  running  only  a  couple  of 
months  on  the  average  and  then  being  sometimes 
paid  off,  but  more  often  shifted  about  or  renewed, 
give  rise  to  the  drawing  of  immense  amounts  of 
foreign  exchange. 

4.  Drawing  of  so-called  "finance-bills,"  of 
which  a  complete  description  will  be  found  in 
chapters  IV  and  VI,  is  the  fourth  source  whence 
foreign  exchange  originates.  Whenever  money 
rates  become  decidedly  higher  in  one  of  the  great 
markets  than  in  the  others,  bankers  at  that  point 
who  have  the  requisite  facilities  and  credit,  ar- 
range with  bankers  in  other  markets  to  allow 
them  (the  bankers  at  the  point  where  money  is 
high)  to  draw  60  or  90  days'  sight  bills.  These 
bills  can  then  be  disposed  of  in  the  exchange  mar- 
ket, dollars  being  realized  on  them,  which  can 
then  be  loaned  out  during  the  whole  life  of  the 
bills.  The  advantages  or  dangers  of  such  an 
operation  will  not  be  touched  upon  here,  the  pur- 
pose of  this  chapter  being  merely  to  set  forth 


FOREIGN    EXCHANGE  13 

clearly  the  sources  from  which  foreign  exchange 
originates. 

And  when  money  is  decidedly  higher  in  New 
York  than  in  London  an  immense  volume  of  for- 
eign exchange  does  originate  from  this  source. 
A  number  of  firms  and  banks,  with  either  their 
own  branches  in  London  or  with  correspondents 
there  to  whom  they  stand  very  close,  are  in  a 
position  where  they  can  draw  very  large  amounts 
of  finance  bills  whenever  they  deem  it  profitable 
and  expedient  to  do  so.  Eventually,  of  course, 
these  60  and  90  day  bills  come  due  and  have  to 
be  settled  by  remittances  of  demand  exchange, 
but  in  the  meantime  the  house  which  drew  them 
will  have  had  the  unrestricted  use  of  the  money. 
In  a  market  like  New  York  this  is  only  too  often 
a  prime  consideration.  With  money  rates  soar- 
ing as  they  do  so  frequently  here,  a  banker  can 
pay  almost  any  commission  his  correspondent 
abroad  demands  and  still  come  out  ahead  on  the 
transaction. 

These  are  the  principal  sources  from  which 
foreign  exchange  originates — shipments  of  mer- 
chandise, sales  abroad  of  securities,  transfer  of 
foreign  banking  capital  to  this  side,  sale  of 
finance-bills.  Other  causes  of  less  importance — 
interest  and  profits  on  American  capital  invested 


14  FOREIGN    EXCHANGE 

in  Europe,  for  instance — are  responsible  for  the 
existence  of  some  quantity  of  exchange,  but  the 
great  bulk  of  it  originates  from  one  of  the  four 
sources  above  set  forth.  In  the  next  chapter 
effort  will  be  made  to  show  whence  arises  the  de- 
mand which  pretty  effectually  absorbs  all  the 
supply  of  exchange  produced  each  year. 


CHAPTER    II 

THE   DEMAND    FOR   BILLS   OF   EX- 
CHANGE 

TURNING   now   to   consideration   of   the 
various  sources  from  which  springs  the 
demand  for  foreign  exchange,  it  appears 
that  they  can  be  divided  about  as  follows : 

1.  The  need  for  exchange  with  which  to  pay  for  imports 
of  merchandise. 

2.  The  need  for  exchange  with  which  to  pay  for  securi- 
ties (American  or  foreign)  purchased  by  us  in  Europe. 

3.  The  necessity  of  remitting  abroad  the  interest  and 
dividends  on  the  huge  sums  of  foreign  capital  invested  here, 
and  the  money  which  foreigners  domiciled  in  this  country 
are  continually  sending  home. 

4.  The  necessity  of  remitting  abroad  freight  and  insur- 
ance money  earned  here  by  foreign  companies. 

5.  Money  to  cover  American  tourists'  disbursements  and 
expenses  of  wealthy  Americans  living  abroad. 

6.  The  need  for  exchange  with  which  to  pay  off  matur- 
ing foreign  short-loans  and  finance-bills. 

1.  Payment  for  merchandise  imported  con- 
stitutes probably  the  most  important  source  of 
demand  for  foreign  exchange.  Merchandise 
brought  into  the  country  for  the  period  given 
herewith  has  been  valued  as  follows: 

15 


16  FOREIGN    EXCHANGE 

1917 $2,952,467,955 

1916  2,391,635,335 

1915  1,674,169,000 

1914  1,893,925,000 

1913  1,813,008,000 

Practically  the  whole  amount  of  these  huge 
importations  has  had  to  be  paid  for  with  bills  of 
exchange.  Whether  the  merchandise  in  ques- 
tion is  cutlery  manufactured  in  England  or 
coffee  grown  in  Brazil,  the  chances  are  it  will  be 
paid  for  (under  a  system  to  be  described  here- 
after) by  a  bill  of  exchange  drawn  on  London 
or  some  other  great  European  financial  center. 
From  one  year's  end  to  the  other  there  is  con- 
stantly this  demand  for  bills  with  which  to  pay 
for  merchandise  brought  into  the  country.  As  in 
the  case  of  exports,  which  are  largest  in  the  Fall, 
there  is  much  more  of  a  demand  for  exchange 
with  which  to  pay  for  imports  at  certain  times  of 
the  year  than  at  others,  but  at  all  times  merchan- 
dise in  quantity  is  coming  into  the  country  and 
must  be  paid  for  with  bills  of  exchange. 

2.  The  second  great  source  of  demand  origi- 
nates out  of  the  necessity  of  making  payment  for 
securities  purchased  abroad.  So  far  as  the  Amer- 
ican participation  in  foreign  bond  issues  is  con- 
cerned, the  past  few  years  have  seen  very  great 


FOREIGN    EXCHANGE  17 

developments.  We  are  not  yet  a  people,  as  are 
the  English  or  the  French,  who  invest  a  large 
proportion  of  their  accumulated  savings  outside 
of  their  own  country,  but  as  our  investment  sur- 
plus has  increased  in  size,  it  has  come  about  that 
American  investors  have  been  going  in  more  and 
more  extensively  for  foreign  bonds.  There  have 
been  times,  indeed,  as  when  the  Japanese  loans 
were  being  floated,  when  very  large  amounts  of 
foreign  exchange  were  required  to  pay  for  the 
bonds  taken  by  American  individuals  and  syndi- 
cates. 

Security  operations  involving  a  demand  for 
foreign  exchange  are,  however,  by  no  means  con- 
fined to  American  participation  in  foreign  bond 
issues.  Accumulated  during  the  course  of  the 
past  half  century,  there  is  a  perfectly  immense 
amount  of  American  securities  held  all  over 
Europe.  The  greater  part  of  this  investment  is 
in  bonds  and  remains  untouched  for  years  at  a 
stretch.  But  then  there  come  times  when,  for 
one  reason  or  another,  waves  of  selling  pass  over 
the  European  holdings  of  "Americans,"  and  we 
are  required  to  take  back  millions  of  dollars' 
worth  of  our  stocks  and  bonds.  Such  selling 
movements  do  not  really  get  very  far  below  the 
surface — they  do  not,  for  instance,  disturb  the 


18  FOREIGN    EXCHANGE 

great  blocks  of  American  bonds  in  which  so  large 
a  proportion  of  many  of  the  big  foreign  fortunes 
are  invested,  but  they  are  apt  to  be,  nevertheless, 
on  a  scale  which  requires  large  amounts  of  ex- 
change to  pay  for  what  we  have  had  to  buy  back. 

The  same  thing  is  true  with  stocks,  though  in 
that  case  the  selling  movements  are  more  fre- 
quent and  less  important.  Europe  is  always  in- 
terested heavily  in  American  stocks,  there  being, 
as  in  the  case  of  bonds,  a  big  fixed  investment  of 
capital,  beside  a  continually  fluctuating  "floating- 
investment,"  In  other  words,  aside  from  their 
fixed  investments  in  our  stocks,  the  foreigners  arc 
continually  speculating  in  them  and  continually 
changing  their  position  as  buyers  and  sellers. 
Selling  movements  such  as  these  do  not  materi- 
ally affect  Europe's  set  position  on  our  stocks,  but 
they  do  result  at  times  in  very  large  amounts  of 
our  stocks  being  dumped  back  upon  us — some- 
times when  we  are  ready  for  them,  sometimes 
when  the  operation  is  decidedly  painful,  as  in  the 
Fall  of  1907.  In  any  case,  when  Europe  sells, 
we  buy.  And  when  we  buy,  and  at  the  rate  of 
millions  of  dollars'  worth  a  day,  there  is  a  big 
demand  for  exchange  with  which  to  pay  for  what 
we  have  bought. 

3.  So  great  is  the  foreign  investment  of  capital 


FOREIGN    EXCHANGE  19 

in  this  country  that  the  necessity  of  remitting  the 
interest  and  dividends  alone  means  another  con- 
tinuous demand  for  very  large  amounts  of  for- 
eign exchange.  Estimates  of  how  much  Euro- 
pean money  is  invested  here  are  little  better  than 
guesses.  The  only  sure  thing  about  it  is  that  the 
figures  run  well  up  into  the  billions  and  that  sev- 
eral hundred  millions  of  dollars'  worth  of  inter- 
est and  dividends  must  be  sent  across  the  water 
each  year.  There  are,  in  the  first  place,  all  the 
foreign  investments  in  what  might  be  called  pri- 
vate enterprise — the  English  money,  for  in- 
stance, invested  in  fruit  orchards,  gold  and  cop- 
per mines,  etc.,  in  the  western  states.  Profits  on 
this  money  are  practically  all  remitted  back  to 
England,  but  no  way  exists  of  even  estimating 
what  they  amount  to.  Aside  from  that  there  are 
all  the  foreign  holdings  of  bonds  and  stocks  in 
our  great  public  corporations,  holdings  whose 
ownership  it  is  impossible  to  trace.  Only  at  the 
interest  periods  at  the  beginning  and  middle  of 
each  year  does  it  become  apparent  how  large  a 
proportion  of  our  bonds  are  held  in  Europe  and 
how  great  is  the  demand  for  exchange  with  which 
to  make  the  remittances  of  accrued  interest.  At 
such  times  the  incoming  mails  of  the  international 
banking  houses  bulge  with  great  quantities  of 


20  FOREIGN    EXCHANGE 

coupons  sent  over  here  for  collection.  For  sev- 
eral weeks  on  either  side  of  the  two  important  in- 
terest periods,  the  exchange  market  feels  the 
stimulus  of  the  demand  for  exchange  with  which 
the  proceeds  of  these  masses  of  coupons  are  to  be 
sent  abroad. 

4.  Freights  and  insurance  are  responsible  for 
a  fourth  important  source  of  demand  for  foreign 
exchange.  A  walk  along  William  Street  in  New 
York  is  all  that  is  necessary  to  give  a  good  idea  of 
the  number  and  importance  of  the  foreign  com- 
panies doing  business  in  the  United  States.  In 
some  form  or  other  all  the  premiums  paid  have 
to  be  sent  to  the  other  side.  Times  come,  of 
course,  like  the  j^ear  of  the  Baltimore  fire,  when 
losses  by  these  foreign  companies  greatly  out- 
balance premiums  received,  the  business  they  do 
thus  resulting  in  the  actual  creation  of  great 
amounts  of  foreign  exchange,  but  in  the  long  run 
— year  in,  year  out — the  remitting  abroad  of  the 
premiums  earned  means  a  steady  demand  for 
exchange. 

With  freights  it  is  the  same  proposition,  except 
that  the  proportion  of  American  shipping  busi- 
ness done  by  foreign  companies  is  much  greater 
than  the  proportion  of  insurance  business  done 
by  foreign  companies.     Since  the  Civil  War  the 


FOREIGN    EXCHANGE  21 

American  mercantile  marine  instead  of  growing 
with  the  country  has  gone  steadily  backward, 
until  now  the  greater  part  of  our  shipping  is  done 
in  foreign  bottoms.  Aside  from  the  other  disad- 
vantages of  such  a  condition,  the  payment  of  such 
great  sums  for  freight  to  foreign  companies  is  a 
direct  economic  drain.  An  estimate  that  the 
yearly  freight  bill  amounts  to  $150,000,000  is 
probably  not  too  high.  That  means  that  in  the 
course  of  every  year  there  is  a  demand  for  that 
amount  of  exchange  with  which  to  remit  back 
what  has  been  earned  from  us. 

5.  Tourists'  expenditures  abroad  are  respons- 
ible for  a  further  heavy  demand  for  exchange. 
Whether  it  is  because  Americans  are  fonder  of 
travel  than  the  people  of  other  countries  or 
whether  it  is  because  of  our  more  or  less  isolated 
position  on  the  map,  it  is  a  fact  that  there  are  far 
more  Americans  traveling  about  in  Europe  than 
people  belonging  to  any  other  nation.  And  the 
sums  spent  by  American  tourists  in  foreign  lands 
annually  aggregate  a  very  large  amount — pos- 
sibly as  much  as  $175,000,000 — all  of  which  has 
eventually  to  be  covered  by  remittances  of  ex- 
change from  this  side. 

Then  again  there  must  be  considered  the  ex- 
penditures of  wealthy  Americans  who  either  live 


22  FOREIGN    EXCHANGE 

abroad  entirely  or  else  spend  a  large  part  of  their 
time  on  the  other  side.  During  the  past  decade 
it  has  come  about  that  every  European  city  of 
any  consequence  has  its  "American  Colony,"  a 
society  no  longer  composed  of  poor  art  students 
or  those  whose  residence  abroad  is  not  a  matter 
of  volition,  but  consisting  now  of  many  of  the 
wealthiest  Americans.  By  these  expatriates 
money  is  spent  extremely  freely,  their  drafts  on 
London  and  Paris  requiring  the  frequent  replen- 
ishment, by  remittances  of  exchange  from  this 
side,  of  their  bank  balances  at  those  points.  Fur- 
thermore, there  must  be  considered  the  great 
amounts  of  American  capital  transferred  abroad 
by  the  marriage  of  wealthy  American  women 
with  titled  foreigners.  Such  alliances  mean  not 
only  the  transfer  of  large  amounts  of  capital  en 
bloc,  but  mean  as  well,  usually,  an  annual  remit- 
tance of  a  very  large  sum  of  money.  No  account 
of  the  money  drained  out  of  the  country  in  this 
way  is  kept,  of  course,  but  it  is  an  item  which  cer- 
tainly runs  up  into  the  tens  of  millions. 

6.  Lastly,  there  is  the  demand  for  exchange 
originating  from  the  paying  off  of  the  short-term 
loans  which  European  bankers  so  continuously 
make  in  the  American  market.  There  is  never  a 
time  nowadavs  when  London  and  Paris  are  lend- 


FOREIGN    EXCHANGE  23 

ing  American  bankers  less  than  $100,000,000  on 
60  or  90  day  bills,  while  the  total  frequently  runs 
up  to  three  or  four  times  that  amount.  The  sum 
of  these  floating  loans  is,  indeed,  changing  all  the 
time,  a  circumstance  which  in  itself  is  responsible 
for  a  demand  for  very  great  amounts  of  foreign 
exchange.  ' 

Take,  for  instance,  the  amount  of  French  and 
English  capital  employed  in  this  market  in  the 
form  of  short-term  loans;  $250,000,000  is  prob- 
ably a  fair  estimate  of  the  average  amount,  and 
90  days  a  fair  estimate  of  the  average  time  the 
loans  run  before  being  paid  off  or  renewed.  That 
means  that  the  quarter  of  a  billion  dollars  of  float- 
ing indebtedness  is  "turned  over"  four  times  a 
year  and  that  means  that  every  year  the  rear- 
rangement of  these  loans  gives  rise  to  a  demand 
for  a  billion  dollars'  worth  of  foreign  exchange. 
These  loaning  operations,  it  must  be  understood, 
both  originate  exchange  and  create  a  demand  for 
it.  They  are  mentioned,  therefore,  in  the  preced- 
ing chapter,  as  one  of  the  sources  from  which  ex- 
change originates,  and  now  as  one  of  the  sources 
from  which,  during  the  course  of  every  year, 
springs  a  demand  for  a  very  great  quantity  of 
exchange. 

The  six  sources  of  demand  for  exchange,  then, 


24  FOREIGN    EXCHANGE 

are  for  the  payment  for  imports;  for  securities 
purchased  abroad ;  for  the  remitting  abroad  of  in- 
terest on  foreign  capital  invested  here  and  the 
money  which  foreigners  in  this  country  send 
home ;  for  remitting  freight  and  insurance  profits 
earned  by  foreign  companies  here;  for  tourists' 
expenses  abroad ;  and  lastly,  for  the  paying  off  of 
foreign  loans.  From  these  sources  spring  prac- 
tically all  the  demand  for  exchange.  In  the  last 
chapter  there  were  set  forth  the  principal  sources 
of  supply.  With  a  clear  understanding  of  where 
exchange  comes  from  and  of  where  it  goes,  it 
ought  now  to  be  possible  for  the  student  of  the 
subject  to  grasp  the  causes  which  bear  on  the 
movement  of  exchange  rates.  That  subject  will 
accordingly  be  taken  up  in  the  next  chapter. 


CHAPTER    III 

THE    RISE    AND    FALL    OF    EX- 
CHANGE   RATES 

GRANTED  that  the  obligations  to  each 
other  of  any  two  given  countries  foot  up 
to  the  same  amount,  it  is  evident  that  the 
rate  of  exchange  will  remain  exactly  at  the  gold 
par — that  in  New  York,  for  instance,  the  price  of 
the  sovereign  will  be  simply  the  mint  value  of  the 
gold  contained  in  the  sovereign.  But  between  no 
two  countries  does  such  a  condition  exist — take 
any  two,  and  the  amount  of  the  obligation  of  one 
to  the  other  changes  every  day,  which  causes  a 
continuous  fluctuation  in  the  exchange  rate — 
sometimes  up  from  the  mint  par,  sometimes 
down. 

Before  going  on  to  discuss  the  various  causes 
influencing  the  movement  of  exchange  rates, 
there  is  one  point  which  should  be  very  clearly 
understood.  Two  countries,  at  least,  are  con- 
cerned in  the  fluctuation  of  every  rate.  Take,  for 
example,  London  and  New  York,  and  assume 
that,  at  New  York,  exchange  on  London  is  fall- 

25 


26  FOREIGN    EXCHANGE 

ing.     That  in  itself  means  that,  in  London,  ex- 
change on  New  York  is  rising. 

For  the  sake  of  clearness,  in  the  ensuing  dis- 
cussion of  the  influences  tending  to  raise  and 
lower  exchange  rates,  New  York  is  chosen  as  the 
point  at  which  these  influences  are  operative.  Con- 
sideration will  be  given  first  to  the  influences 
which  cause  exchange  to  go  up.  In  a  general  way, 
it  will  be  noticed,  they  conform  with  the  sources 
of  demand  for  exchange  given  in  the  previous 
chapter.  They  may  be  classified  about  as  follows : 

1.  Large  imports,  calling  for  large  amounts  of  exchange 
with  which  to  make  the  necessary  payments. 

!&  Large  purchases  of  foreign  securities  by  us,  or  re- 
purchase of  our  own  securities  abroad,  calling  for  large 
amounts  of  exchange  with  which  to  make  payment. 

&  Coming  to  maturity  of  issues  of  American  bonds  held 
abroad. 

4.  Low  money  rates  here,  which  result  in  a  demand  for 
exchange  with  which  to  send  banking  capital  out  of  the 
country. 

&  High  money  rates  at  some  foreign  centre  which  cre- 
ate a  great  demand  for  exchange  drawn  on  that  centre. 

1.  Heavy  imports  are  always  a  potent  factor 
in  raising  the  level  of  exchange  rates.  Under 
whatever  financial  arrangement  or  from  what- 
ever   point    merchandise   is    imported   into   the 


FOREIGN    EXCHANGE  27 

United  States,  payment  is  almost  invariably 
made  by  draft  on  London,  Paris,  or  Berlin.  At 
times  when  imports  run  especially  heavy,  demand 
from  importers  for  exchange  often  outweighs 
every  other  consideration,  forcing  rates  up  to  high 
levels.  A  practical  illustration  is  to  be  found  in 
the  inpour  of  merchandise  which  took  place  just 
before  the  tariff  legislation  in  1909.  Convinced 
that  duties  were  to  be  raised,  importers  rushed 
millions  of  dollars'  worth  of  merchandise  of  every 
description  into  the  country.  The  result  was  that 
the  demand  for  exchange  became  so  great  that  in 
spite  of  the  fact  that  it  was  the  season  when  ex- 
ports normally  meant  low  exchange,  rates  were 
pushed  up  to  the  gold  export  point. 

2.  Heavy  purchasing  movements  of  our  own 
or  foreign  securities,  on  the  other  side,  are  the 
second  great  influence  making  for  high  exchange. 
There  come  times  when,  for  one  reason  or  an- 
other, the  movement  of  securities  is  all  one  way, 
and  when  it  happens  that  for  any  cause  we  are 
the  ones  who  are  doing  the  buying,  the  exchange 
market  is  likely  to  be  sharply  influenced  upward 
by  the  demand  for  bills  with  which  to  make  pay- 
ments. Such  movements  on  a  greater  or  less  scale 
go  on  all  the  time  and  constitute  one  of  the  prin- 
cipal factors  which  exchange  managers  take  into 


28  FOREIGN    EXCHANGE 

consideration  in  making  their  estimate  of  possible 
exchange  market  fluctuations. 

It  is  interesting,  for  instance,  to  note  the  move- 
ment of  foreign  exchange  at  times  when  a  heavy 
selling  movement  of  American  stocks  by  the  for- 
eigners is  under  way.  Origin  of  security-selling 
on  the  Stock  Exchange  is  by  no  means  easy  to 
trace,  but  there  are  times  when  the  character  of 
the  brokers  doing  the  selling  and  the  very  nature 
of  the  stocks  being  disposed  of  mean  much  to  the 
experienced  eye.  Take,  for  instance,  a  day  when 
half  a  dozen  brokers  usually  identified  with  the 
operations  of  the  international  houses  are  consist- 
ently selling  such  stocks  as  Missouri,  Kansas  & 
Texas,  Baltimore  &  Ohio,  or  Canadian  Pacific — 
whether  or  not  the  inference  that  the  selling  is  for 
foreign  account  is  correct  can  very  probably  be 
read  from  the  movement  of  the  exchange  market. 
If  it  is  the  case  that  the  selling  comes  from  abroad 
and  that  we  are  buying,  large  orders  for  foreign 
exchange  are  almost  certain  to  make  their  ap- 
pearance and  to  give  the  market  a  very  strong 
tone  if  not  actually  to  urge  it  sharply  upward. 
Such  orders  are  not  likely  to  be  handled  in  a  way 
which  makes  them  apparent  to  everybody,  but  as 
a  rule  it  is  impossible  to  execute  them  without 
creating  a  condition  in  the  exchange  market  ap- 


FOREIGN    EXCHANGE  29 

parent  to  every  shrewd  observer.  And,  as  a  mat- 
ter of  fact,  many  an  operation  in  the  interna- 
tional stocks  is  based  upon  judgment  as  to  what 
the  action  of  the  exchange  market  portends.  Sim- 
ilarly— the  other  way  around — exchange  man- 
agers very  frequently  operate  in  exchange  on  the 
strength  of  what  they  judge  or  know  is  going  to 
happen  in  the  market  for  the  international  stocks. 
With  the  exchange  market  sensitive  to  develop- 
ments, knowledge  that  there  is  to  be  heavy  selling 
in  some  quarter  of  the  stock  market,  from  abroad, 
is  almost  equivalent  to  knowledge  of  a  coming 
sharp  rise  in  exchange  on  London. 

Perhaps  the  best  illustration  of  how  exchange 
can  be  affected  by  foreign  selling  of  our  securities 
occurred  just  after  the  beginning  of  the  panic 
period  in  October  of  1907.  Under  continuous 
withdrawals  of  New  York  capital  from  the  for- 
eign markets,  exchange  had  sold  down  to  a  very 
low  point.  Suddenly  came  the  memorable  selling 
movement  of  "Americans"  by  English  and  Ger- 
man investors.  Within  two  or  three  days  perhaps 
a  million  shares  of  American  stocks  were  jetti- 
soned in  this  market  by  the  foreigners,  while  ex- 
change rose  by  leaps  and  bounds  nearly  10  cents 
to  the  pound,  to  the  unheard-of  price  of  4.91.  No- 
body had  exchange  to  sell  and  almost  overnight 


30  FOREIGN    EXCHANGE 

there  had  been  created  a  demand  for  tens  of  mil- 
lions of  dollars'  worth. 

3.  The  coming  to  maturity  of  American  bonds 
held  abroad  is  another  influencing  factor  closely 
kept  track  of  by  dealers  in  exchange.  So  exten- 
sive is  the  total  foreign  investment  in  American 
bonds  that  issues  are  coming  due  all  the  time. 
Where  some  especially  large  issue  runs  off  with- 
out being  funded  with  new  bonds,  demand  for  ex- 
change often  becomes  very  strong.  Especially  is 
this  the  case  with  the  short-term  issues  of  the  rail- 
roads and  most  especially  with  New  York  City 
revenue  warrants  which  have  become  so  exceed- 
ingly popular  a  form  of  investment  among  the 
foreign  bankers.  In  spite  of  its  mammoth  debt, 
New  York  City  is  continually  putting  out  reve- 
nue warrants,  the  operation  amounting,  in  fact, 
to  the  issue  of  its  notes.  Of  late  years  Paris  bank- 
ers, especially,  have  found  the  discounting  of 
these  "notes"  a  profitable  operation  and  have  at 
times  taken  them  in  big  blocks. 

Whenever  one  of  these  blocks  of  revenue  war- 
rants matures  and  has  to  be  paid  off,  the  ex- 
change market  is  likely  to  be  strongly  affected. 
Accumulation  of  exchange  in  preparation  is  like- 
ly to  be  carried  on  for  some  weeks  ahead,  but  even 
at  that  the  resulting  steady  demand  for  bills  often 


FOREIGN    EXCHANGE  31 

exerts  a  decidedly  stimulating  influence.  Ex- 
perienced exchange  managers  know  at  all  times 
just  what  short-term  issues  are  coming  due,  about 
what  proportion  of  the  bonds  or  notes  have  found 
their  way  to  the  other  side,  just  how  far  ahead  the 
exchange  is  likely  to  be  accumulated.  Repayment 
operations  of  this  kind  are  often  almost  a  domi- 
nant, though  usually  temporary,  influence  on  the 
price  of  exchange. 

4.  Low  money  rates  are  the  fourth  great  fac- 
tor influencing  foreign  exchange  upward.  When- 
ever money  is  cheap  at  any  given  center,  and  bor- 
rowers are  bidding  only  low  rates  for  its  use,  lend- . 
ers  seek  a  more  profitable  field  for  the  employ-  \ 
ment  of  their  capital.  It  has  come  about  during 
the  past  few  years  that  so  far  as  the  operation  of 
loaning  money  is  concerned,  the  whole  financial 
world  is  one  great  market,  New  York  bankers 
nowadays  loaning  out  their  money  in  London 
with  the  same  facility  with  which  they  used  to 
loan  it  out  in  Boston  or  Philadelphia.  So  close 
have  become  the  financial  relationships  between 
leading  banking  houses  in  New  York  and  Lon- 
don that  the  slightest  opportunity  for  profitable 
loaning  operations  is  immediately  availed  of. 

Money  rates  in  the  New  York  market  are  not 
often  less  attractive  than  those  in  London,  so  that 


82  FOREIGN    EXCHANGE 

American  floating  capital  is  not  generally  em- 
ployed in  the  English  market,  but  it  does  occa- 
sionally come  about  that  rates  become  abnormally 
low  here  and  that  bankers  send  away  their  bal- 
ances to  be  loaned  out  at  other  points.  During 
long  periods  of  low  money,  indeed,  it  often  hap- 
pens that  large  lending  institutions  here  send 
away  a  considerable  part  of  their  deposits,  to  be 
steadily  employed  for  loaning  out  and  discount- 
ing bills  in  some  foreign  market.  Such  a  time 
was  the  long  period  of  stagnant  money  conditions 
following  the  1907  panic.  Trust  companies  and 
banks  who  were  paying  interest  on  large  deposits 
at  that  time  sent  very  large  amounts  of  money  to 
the  other  side  and  kept  big  balances  running  with 
their  correspondents  at  such  points  as  Amster- 
dam, Copenhagen,  St.  Petersburg,  etc., — any- 
where, in  fact,  where  some  little  demand  for 
money  actually  existed.  Demand  for  exchange 
with  which  to  send  this  money  abroad  was  a  big 
factor  in  keeping  exchange  rates  at  their  high 
level  during  all  that  long  period. 

5.  High  money  rates  at  some  given  foreign 
point  as  a  factor  in  elevating  exchange  rates  on 
that  point  might  almost  be  considered  as  a  corol- 
lary of  low  money  here,  but  special  considerations 
often  govern  such  a  condition  and  make  it  worth 


FOREIGN    EXCHANGE  33 

while  to  note  its  effect.  Suppose,  for  instance, 
that  at  a  time  when  money  market  conditions  all 
over  the  world  are  about  normal,  rates,  for  any 
given  reason,  begin  to  rise  at  some  point,  say 
London.  Instantly  a  flow  of  capital  begins  in 
that  direction.  In  New  York,  Paris,  Berlin  and 
other  centers  it  is  realized  that  London  is  bidding 
better  rates  for  money  than  are  obtainable  locally, 
and  bankers  forthwith  make  preparations  to  in- 
crease the  sterling  balances  they  are  employing  in 
London.  Exchange  on  that  particular  point 
being  in  such  demand,  rates  begin  to  rise,  and 
continue  to  rise,  according  to  the  urgency  of  the 
demand. 

Particular  attention  will  be  given  later  on  to 
the  way  in  which  the  Bank  of  England  and  the 
other  great  foreign  banks  manipulate  the  money 
market  and  so  control  the  course  of  foreign  ex- 
change upon  themselves,  but  in  passing  it  is  well 
to  note  just  why  it  is  that  when  the  interest  rate 
at  any  given  point  begins  to  go  up,  foreign  ex- 
change drawn  upon  that  point  begins  to  go  up, 
too.  Remittances  to  the  point  where  the  better 
bid  for  money  is  being  made,  are  the  very  simple 
explanation.  Bankers  want  to  send  money  there, 
and  to  do  it  they  need  bills  of  exchange.  An 
urgent  enough  demand  inevitably  means  a  rise  in 

3 


34  FOREIGN    EXCHANGE 

the  quotation  at  which  the  bills  are  obtainable. 
Which  suggests  very  plainly  why  it  is  that  when 
the  Directors  of  the  Bank  of  England  want  to 
raise  the  rate  of  exchange  upon  London,  at  New 
York  or  Paris  or  Berlin,  they  go  about  it  by 
tightening  up  the  English  money  market. 

The  foregoing  are  the  principal  causes  making 
for  high  exchange.  The  causes  which  make  up 
for  low  rates  must  necessarily  be  to  a  certain  ex- 
tent merely  the  converse,  but  for  the  sake  of 
clearness  they  are  set  down.  The  division  is  about 
as  follows: 

1.  Especially  heavy  exports  of  merchandise. 

2.  Large  purchases  of  our  stocks  by  the  foreigners  and 
the  placing  abroad  of  blocks  of  American  bonds. 

3.  Distrust  on  our  part  of  financial  conditions  existing 
at  some  point  abroad  where  there  are  carried  large  deposits 
of  American  capital. 

4.  High  money  rates  here. 

5.  Unprofitably  low  loaning  rates  at  some  important  for- 
eign centre  where  American  bankers  ordinarily  carry  large 
balances  on  deposit. 

1.  Just  as  unusually  large  imports  of  commod- 
ities mean  a  sharp  demand  for  exchange  with 
which  to  pay  for  them,  unusually  large  exports 
mean  a  big  supply  of  bills.  In  a  previous  chapter 
it  has  been  explained  how,  when  merchandise  is 
shipped  out  of  the  country,  the  shipper  draws  his 


FOREIGN    EXCHANGE  35 

draft  upon  the  buyer,  in  the  currency  of  the 
country  to  which  the  merchandise  goes.  When 
exports  are  heavy,  therefore,  a  great  volume  of 
bills  of  exchange  drawn  in  various  kinds  of  cur- 
rency comes  on  the  market  for  sale,  naturally  de- 
pressing rates. 

Exports  continue  on  a  certain  scale  all  through 
the  year,  but,  like  imports,  are  heavier  at  some 
times  than  others.  In  the  Fall,  for  instance, 
when  the  year's  crops  are  being  exported,  ship- 
ments out  of  the  country  invariably  reach  their 
zenith,  the  export  nadir  being  approached  in  mid- 
summer, when  the  crop  has  been  mostly  exported 
and  shipments  of  manufactured  goods  are  run- 
ning light. 

From  the  middle  of  August,  when  the  first 
of  the  new  cotton  crop  begins  to  find  its  way  to 
the  seaport,  until  the  middle  of  December,  when 
the  bulk  of  the  corn  and  wheat  crop  exports  have 
been  completed,  exchange  inlvery  great  volume 
finds  its  way  into  the  New  York  market.  Nor- 
mally this  is  the  season  of  low  rates,  for  which 
reason  many  shippers  of  cotton  and  grain,  who 
know  months  in  advance  approximately  how 
much  they  will  ship,  contract  ahead  of  time  with 
exchange  dealers  in  New  York  for  the  sale  of  the 
bills  they  know  they  will  have.     By  so  doing, 


36  FOREIGN    EXCHANGE 

shippers  are  often  able  to  obtain  very  much  bet- 
ter rates.  They  can  then  protect  themselves,  at 
least,  from  the  extremely  low  rates  which  they 
may  be  forced  to  take  if  they  wait  and  accept 
going  rates  at  a  time  when  shippers  all  over  the 
country  are  trying  to  sell  their  bills  at  the  same 
time. 

How  great  is  the  rush  of  exchange  into  market 
may  be  seen  from  the  statistics  of  cotton 
exports  during  the  period  given  below.  Not  all 
of  this  cotton  goes  out  during  the  last  four 
months  of  the  year,  but  the  greater  part  of  it 
does  and,  furthermore,  cotton,  while  the  most  im- 
portant, is  only  one  of  the  domestic  products  ex- 
ported in  the  autumn. 

Money  Value  of  Cotton  Exported 

1917  $575,306,634 

1916  545,228,684 

1915  ., 376,217,000 

1914-  610,475,000 

1913  547,357,000 

During  the  autumn  months,  under  normal  con- 
ditions, the  advantage  is  all  with  the  buyer  of 
foreign  exchange.  By  every  mail  huge  packages 
of  bills,  drawn  against  shipments  of  cotton,  wheat 
and  corn,  come  pouring  into  the  New  York  mar- 


FOREIGN    EXCHANGE  37 

ket.  Bankers'  portfolios  become  crowded  with 
bills;  remittances  by  each  steamer,  in  the  case  of 
some  of  the  big  bankers,  run  up,  literally,  into  the 
millions  of  dollars.  Naturally,  any  one  wanting 
bankers'  exchange  is  usually  able  to  secure  it  at  a 
low  price. 

2.  With  regard  to  the  second  influence  mak- 
ing for  low  exchange,  sale  of  American  bonds  or 
stocks  abroad,  no  season  can  be  set  when  the  in- 
fluence is  more  likely  to  be  operative  than  at  any 
other,  unless,  possibly,  it  be  the  Spring,  when 
money  rates  are  more  apt  to  be  low  and  bond  is- 
sues larger  than  at  any  other  time  of  the  year. 
No  time,  however,  can  be  definitely  set — there 
are  years  when  the  bulk  of  the  new  issues  are 
brought  out  in  the  Spring  and  other  years  when 
the  Fall  season  sees  most  of  the  new  financing. 
But  whatever  the  time  of  the  year,  one  thing  is 
certain — the  issue  of  any  amount  of  American 
bonds  with  Europe  participating  largely  means  a 
full  supply  of  foreign  exchange  not  only  during 
the  time  the  issues  are  actually  being  brought  out, 
but  for  long  afterward. 

There  used  to  be  a  saying  among  exchange 
dealers  that  cotton  exports  make  exchange  faster 
than  anything,  but  nowadays  bond  sales  abroad 
have  come  to  take  first  place.    For  foreign  par- 


38  FOREIGN    EXCHANGE 

ticipation  in  syndicates  formed  to  underwrite  new 
issues  almost  invariably  means  the  drawing  of 
bills  representing  the  full  amount  of  the  foreign 
participation.  A  syndicate  is  formed,  for  in- 
stance, to  take  off  the  hands  of  the  X  Y  Z  rail- 
road $30,000,000  of  new  bonds,  the  arrangement 
being  that  the  railroad  is  to  receive  its  money  at 
once  and  that  the  syndicate  is  to  take  its  own  time 
about  working  off  the  bonds.  Half  the  amount, 
say,  has  been  allotted  to  foreign  houses.  Imme- 
diately, the  drawing  of  £3,000,000,  or  francs  75,- 
000,000,  as  the  case  may  be,  begins.  The  foreign 
houses  have  to  raise  the  money,  and  in  nine  cases 
out  of  ten,  their  way  of  doing  it  is  to  arrange  with 
some  representative  abroad  to  let  them  draw  long 
drafts,  against  the  deposit  of  securities  on  this 
side.  These  drafts,  in  pounds  or  francs,  at  sixty 
to  ninety  days'  sight,  they  can  sell  in  the  exchange 
market  for  dollars,  thus  securing  the  money  they 
have  agreed  to  turn  over  to  the  railroad.  In  the 
meantime,  during  the  life  of  the  drafts  they  have 
set  afloat  and  before  they  come  due  and  have  to 
be  paid  off,  the  bankers  here  can  go  about  selling 
the  bonds  and  getting  back  their  money.  Per- 
haps before  the  sixty  or  ninety  days,  as  the  case 
may  be,  are  over,  the  syndicate  may  have  sold  out 
all  its  bonds  and  its  foreign  members  have  been 


FOREIGN    EXCHANGE  39 

put  in  a  position  where  they  can  pay  off  all  the 
drafts  they  set  afloat  originally  in  order  to  raise 
the  money. 

Very  often,  however,  it  will  happen  that  on 
account  of  one  reason  or  another,  sixty  days  pass 
or  ninety  days  pass  without  the  syndicate  having 
been  able  to  dispose  of  its  bonds.  In  that  case 
the  long  bills  drawn  on  the  foreign  bankers  have 
to  be  "renewed" — that  being  a  process  for  which 
ample  provision  has,  of  course,  been  made.  In  a 
succeeding  chapter,  full  description  of  how  long 
bills  of  exchange  coming  due  are  renewed  will  be 
made.  Just  here  it  is  only  necessary  to  say  that 
most  or  all  of  the  money  necessary  to  pay  off  the 
maturing  bills  is  raised  by  selling  another  batch 
of  "sixties"  or  "nineties,"  an  operation  which 
throws  the  maturity  two  or  three  months  further 
ahead. 

From  this  outline  of  the  way  foreign  participa- 
tion in  American  bond  issues  is  financed,  it  can 
be  seen  that  every  time  a  big  issue  of  bonds  of  a 
railroad  or  industrial  in  which  European  inves- 
tors are  actively  interested,  is  brought  out,  it 
means  a  large  supply  of  foreign  exchange  created 
and  suddenly  thrown  on  the  exchange  market  for 
sale.  Not  any  more  suddenly  or  publicly  than  the 
bankers  concerned  can  help,  but  still  necessarily 


40  FOREIGN    EXCHANGE 

so  to  a  great  degree,  because  big  bond  issues  can 
only  be  made  with  the  full  knowledge  and  coop- 
eration of  a  large  part  of  the  public.  Bankers 
who  know  in  advance  of  large  issues  likely  to  be 
made  and  in  which  they  know  they  will  be  asked 
to  participate,  often  sell  "futures"  covering  the 
exchange  they  foresee  their  participation  will 
bring  into  existence,  but  as  a  general  rule  it  may 
be  set  down  that  heavy  issues,  involving  the  sale 
abroad  of  large  amounts  of  bonds,  are  a  most  de- 
pressing factor  on  the  foreign  exchange  market. 
Especially  so,  as  the  participants  who  have  agreed 
to  turn  over  the  money  to  the  railroad,  must  sell 
bills  to  raise  it,  even  if  the  horde  of  speculators 
and  "trailers"  who  are  always  on  the  lookout  for 
such  opportunities,  make  every  effort  to  sell  the 
market  out  from  under  their  feet. 

3.  Uneasiness  with  regard  to  the  stability  of 
the  financial  situation  at  some  point  abroad 
where  American  bankers  usually  carry  large  bal- 
ances is  another  circumstance  which  often  de- 
presses the  exchange  market  sharply.  "Trouble 
in  the  Balkans"  and  "trouble  over  the  Moroccan 
situation"  are  two  bugbears  which  have  for  years 
back  furnished  the  keynote  for  many  swoops 
downward  in  the  exchange  market,  and  for  years 
after  this  book  is  published  will  probably  con- 


FOREIGN    EXCHANGE  41 

tinue  to  do  so.  Money  on  deposit  at  a  point  sev- 
eral thousand  miles  away  is  naturally  very  sensi- 
tive, and  the  least  suspicion  of  financial  trouble 
is  sufficient  to  cause  its  withdrawal.  Withdrawal 
of  bankers'  balances  from  a  foreign  city  means 
offerings  of  exchange  drawn  on  that  point  with 
resultant  decline  in  rates. 

In  the  everyday  life  of  the  exchange  market, 
political  developments  of  an  unfavorable  charac- 
ter and  war  rumors  are  about  the  most  frequent 
and  potent  influences  toward  the  condition  of  un- 
easiness above  referred  to.  Few  war  rumors  ever 
come  to  anything,  but  there  are  times  when  they 
circulate  with  astonishing  frequency  and  persist- 
ence and  cause  decided  uneasiness  concerning 
financial  conditions  at  important  points.  At  such 
times  bankers  having  money  on  deposit  at  those 
points  are  apt  to  become  influenced  by  the  drift 
of  sentiment  and  to  draw  down  their  balances. 
Here,  again,  operators  in  exchange,  keenly  on  the 
alert  for  such  chances,  will  very  likely  begin  to 
sell  the  exchange  market  short  and  often  succeed 
in  breaking  it  to  a  degree  entirely  unwarranted 
by  the  known  facts. 

4.  But  of  all  the  sure  depressing  influences  on 
exchange,  none  is  more  sure  than  a  rise  in  the 
money  market.    More  gradual  usually  than  a  de- 


42  FOREIGN    EXCHANGE 

cline  caused  by  such  an  influence  as  the  sale  of 
American  bonds  abroad,  the  influence  of  a  rising 
level  of  money  rates  is  nevertheless  far  more 
certain. 

The  theory  of  this  "counter"  movement  in 
money  rates  and  exchange  is  simply  that  when 
money  rates  rise,  say  at  a  point  like  New  York, 
American  bankers  find  it  profitable  to  draw  in 
their  deposits  from  all  over  Europe  for  the  pur- 
pose of  using  the  money  in  New  York.  Such  a 
process  means  a  wholesale  drawing  of  bills  of  ex- 
change on  all  the  leading  European  cities,  with 
consequent  offering  of  the  bills  and  price-depres- 
sion in  the  leading  American  exchange  markets. 

The  number  of  banks  scattered  all  over  the 
United  States  which  keep  running  deposit  ac- 
counts in  the  leading  European  cities  has  become 
surprisingly  great  during  the  past  ten  years,  and 
a  movement  to  bring  home  this  capital  has  to  go 
only  a  little  way  before  it  reaches  very  large  pro- 
portions. That  is  exactly  what  happens  when 
money  rates  at  a  point  like  New  York  become 
decidedly  more  attractive  than  they  are  over  on 
the  other  side.  Arrangements  with  foreign  cor- 
respondents usually  call  for  a  minimum  balance 
of  considerable  size,  which  must  be  left  intact,  but 
under  ordinary  circumstances  there  is  consider- 


FOREIGN    EXCHANGE  43 

able  leeway,  and  when  the  better  opportunity  for 
loaning  presents  itself  here,  drafts  on  balances 
abroad,  in  large  aggregate  amount,  are  apt  to  be 
drawn  and  sold  in  this  market.  Especially  is  this 
the  case  when  the  cause  of  the  higher  money  level 
appears  to  be  deep-rooted  and  the  outlook  is  for 
a  continuance  of  the  condition  for  some  time  to 
come. 

5.  Lastly,  as  a  depressing  factor,  there  is  to  be 
considered  the  condition  which  arises  when  money 
at  some  important  foreign  center,  such  as  London 
or  Paris,  begins  to  ease  decidedly.  Large  re- 
ceipts of  gold  from  the  mines,  a  bettering  politi- 
cal outlook — these  or  many  other  causes  may 
bring  it  about  that  money  in  London,  for  in- 
stance, after  a  period  of  high  rates,  may  ease  off 
faster  than  in  Berlin  or  Hamburg.  As  a  result, 
American  bankers  having  large  balances  in  Lon- 
don and  finding  it  difficult  to  employ  them  profit- 
ably there,  any  longer,  either  withdraw  them  en- 
tirely or  have  the  money  transferred  to  some  other 
point.  In  either  case  the  operation  will  result  in 
depressing  the  rate  of  exchange  on  London,  for 
the  American  banker  will  either  draw  on  London 
himself  or,  if  he  wants  to  transfer  the  money  to 
Berlin  or  Hamburg,  will  instruct  the  German 
bankers  by  cable  to  draw  for  his  account  on  Lon- 


44  FOREIGN    EXCHANGE 

don.  In  whatever  way  it  is  accomplished,  the 
withdrawal  of  capital  from  any  banking  point 
tends  to  lower  the  rate  of  foreign  exchange  on 
that  point. 

These  are  the  main  influences  bearing  on  the 
fluctuation  of  exchange.  Needless  to  say  they 
are  not  exerted  all  one  way,  or  one  at  a  time,  as 
set  forth.  The  international  money  markets  are  a 
most  decidedly  complex  proposition,  and  there  is 
literally  never  a  time  when  several  influences 
tending  to  put  rates  up  are  not  conflicting  with 
several  influences  tending  to  put  rates  down.  The 
actual  movement  of  the  rate  represents  the  rela- 
tive strength  of  the  two  sets  of  influences.  To  be 
able  to  "size  up"  the  influences  present  and  to 
gauge  what  movement  of  rates  they  will  result 
in,  is  an  operation  requiring,  first,  knowledge, 
then  judgment.  The  former  qualification  can 
perhaps  be  derived,  in  small  degree,  from  study 
of  the  foregoing  pages.  The  latter  is  a  matter  of 
mental  calibre  and  experience. 


CHAPTER    IV 

THE      VARIOUS      KINDS      OF      EX- 
CHANGE 

BEFORE  taking  up  the  question  of  the  ac- 
tivities of  the  foreign  exchange  depart- 
ment and  the  question  of  how  bankers 
make  money  dealing  in  exchange,  it  may  be  well 
to  fix  in  mind  clearly  what  the  various  forms  of 
foreign  exchange  are.    Following  is  a  description 


Form  of  Commercial  Long  Bill 

of  the  most  important  classes  of  bills  bought  and 
sold  in  the  New  York  market : 

(1/   Commercial  Long  Bills 

Drafts  drawn  by  shippers  of  merchandise  upon 
buyers  abroad,  or  upon  the  banking  representa- 

45 


46  FOREIGN    EXCHANGE 

tives  of  the  buyers  abroad,  at  thirty  days'  sight 
or  more.  The  drafts  may  be  accompanied  by 
shipping  documents  or  may  be  "clean."  The 
former  kind  of  bill  making  up  the  greater  part 
of  the  whole  amount  of  foreign  exchange  dealt  in 
in  the  New  York  market,  will  be  described  first. 

Suppose  a  cotton  dealer  in  Memphis  to  have 
sold  one  hundred  bales  of  cotton  to  a  spinner  in 
Liverpool,  the  arrangement  being  that  the  Eng- 
lish buyer  is  to  be  drawn  on  at  sixty  days'  sight. 
The  first  tiling  the  Memphis  merchant  does  is  to 
ship  the  cotton  on  its  way  to  Liverpool,  receiving 
from  the  railroad  company  a  receipt  known  as  a 
"bill  of  lading."  At  the  same  time  he  arranges 
for  the  insurance  of  the  cotton,  receiving  from 
the  insurance  company  a  little  certificate  stating 
that  the  insurance  has  been  effected. 

The  next  step  is  for  the  Memphis  shipper  to 
draw  the  draft  on  the  Liverpool  buyer — or  upon 
some  bank  abroad  designated  by  the  buyer.  This 
draft  is  drawn  in  pounds  sterling  for  the  equiva- 
lent of  the  dollar  value  of  the  cotton  and  made 
payable  sixty  days  after  the  party  abroad  on 
whom  it  is  drawn  has  seen  it  and  written  "ac- 
cepted" across  its  face.  This  draft,  the  bill  of 
lading  received  from  the  shipping  company,  and 
the  insurance  certificate  received  from  the  insur- 


FOREIGN    EXCHANGE  47 

ance  company  are  then  pinned  together  and  con- 
stitute a  complete  "commercial  long  bill  with 
documents  attached." 

Other  less  important  documents  go  with  such 
a  bill.  Sometimes  invoices  showing  the  weight 
and  price  of  the  cotton  go  along  with  it  and 
sometimes  there  is  also  attached  a  "hypothecation 
slip"  which  formally  turns  over  the  right  to  the 
goods  to  the  Memphis  or  New  York  banker  who 
buys  the  draft  and  accompanying  documents 
from  the  Memphis  cotton  shipper.  Sometimes, 
too,  insurance  is  effected  by  the  buyer  abroad,  in 
which  case  there  may  be  no  insurance  certificate. 
But  in  the  main,  one  of  these  "documentary" 
commercial  bills  consists  of  the  draft  itself,  the 
bill  of  lading,  and  an  insurance  certificate. 

Having  pinned  the  document  and  the  draft  to- 
gether, the  Memphis  cotton  shipper  is  in  posses- 
sion of  an  instrument  which  he  can  dispose  of  for 
dollars.  This  he  does  either  by  selling  it  to  his 
bank  in  Memphis  or  by  sending  it  to  New  York, 
in  order  that  it  may  be  sold  there  in  the  exchange 
market  at  the  current  rate  of  exchange.  Say,  the 
bill  of  exchange  is  drawn  on  London  at  sixty 
days'  sight,  for  £1,000.  The  buying  price  for 
such  a  draft  will  be,  perhaps,  4.84.  The  Memphis 
shipper  gets  his  check  for  $4,840,  and  is  out  of  the 


48  FOREIGN    EXCHANGE 

transaction.  Tne  bill  nas  passed  into  a  banker's 
hands,  who  will  send  it  abroad — deposit  it  in  some 
foreign  bank  where  he  keeps  a  balance. 

As  to  the  rate  of  4.84  received  by  the  shipper,  it 
is  to  be  noted  that  had  the  bill  been  drawn  at  less 
than  sixty  days'  sight,  he  would  have  received 
more  dollars  for  it,  while  if  it  had  been  drawn  at 
more  than  sixty  days'  sight,  he  would  have  re- 
ceived less  for  it.  The  longer  the  banker  who 
takes  the  draft  off  the  shipper's  hands  has  to  wait 
until  he  can  get  his  money  back  on  it,  the  lower, 
naturally,  the  rate  of  exchange  he  is  willing  to 
pay.  On  the  same  day  that  demand  drafts  are 
selling  at  4.87,  sixty-day  drafts  may  be  selling  at 
4.84  and  ninety-day  drafts  at  4.83. 

Assume,  in  this  particular  case,  that  the  draft 
has  been  taken  off  the  shipper's  hands  by  some 
foreign  exchange  banker  in  New  York.  By  the 
very  first  steamer  the  latter  will  forward  it  to  his 
banking  correspondent  abroad,  with  instructions 
to  present  it  at  once  to  the  parties  on  whom  it  is 
drawn,  in  order  that  they  may  mark  it  "accepted 
— payable  such-and-such-a-date."  After  that  the 
bill  is  a  double  obligation  of  the  drawer  and  the 
drawee,  and  may  be  discounted  in  the  open  mar- 
ket, for  cash. 

Just  here  it  is  necessary  to  digress  and  state 


FOREIGN    EXCHANGE  49 

that  documentary  commercial  bills  are  of  two 
kinds — "acceptance"  bills  and  "payment"  bills. 
In  the  case  of  the  first-named,  the  documents  are 
delivered  to  the  party  on  whom  the  bill  is  drawn 
as  soon  as  he  "accepts"  the  bill,  which  puts  him  in 
a  position  to  get  possession  of  the  merchandise  at 
once.  In  the  case  of  a  "payment"  bill,  the  credit 
of  the  man  on  whom  it  is  drawn  is  not  good 
enough  to  entitle  him  to  such  a  privilege,  and  the 
only  way  he  can  get  actual  possession  of  the  goods 
is  to  actually  pay  the  draft  under  a  rebate-of-in- 
terest  arrangement.  All  bills  drawn  on  banks  are 
naturally  "acceptance"  bills;  and  being  discounta- 
ble and  thus  immediately  convertible  into  cash 
abroad,  command  a  better  rate  of  exchange  in  the 
New  York  market  than  "payment"  bills,  which 
may  be  allowed  to  run  all  the  way  to  maturity 
before  a  single  pound  sterling  is  paid  on  them. 

Except  in  the  case  of  the  shipment  of  perisha- 
ble merchandise — grain  shipped  in  bulk,  for  in- 
stance. In  that  case  the  buyer  on  the  other  side 
cannot  afford  to  let  the  draft  run,  because  the 
merchandise  would  spoil.  He  is  simply  forced  to 
pay  it  under  rebate,  in  order  to  get  possession  of 
the  grain.  And  the  rebate  being  always  less  than 
the  discount  rate,  less  pounds  sterling  come  off 
the  face  of  the  bill  in  the  process  of  rebating  than 


50  FOREIGN    EXCHANGE 

of  discounting.  For  which  reason  sixty-day  bills 
drawn  against  shipments  of  grain — documents 
deliverable  only  on  payment  under  rebate — com- 


**.A2$U,    ^A"* 


Ctissisa^&-isa~ 


Form  of  Clean  Blil 


mand  a  better  rate  of  exchange  even  than  the  very 
best  of  cotton  "acceptance"  bills  drawn  on  banks. 

0    Clean  Bills 

Where  the  drafts  of  the  merchants  of  one  coun- 
try drawn  upon  the  merchants  or  bankers  of  an- 
other are  unaccompanied  by  shipping  documents 
they  are  said  to  be  "clean."  Bills  of  this  kind 
may  originate  from  the  transfer  of  capital  from 
one  country  to  another  or  may  represent  draw- 
ings against  shipments  of  merchandise  previously 
made.  It  is  not  unusual,  indeed,  where  the  re- 
lationship between  some  foreign  merchant  and 


FOREIGN    EXCHANGE  51 

some  American  merchant  is  very  close,  for  the  one 
to  ship  merchandise  to  the  other  without  drawing 
drafts  against  the  shipment  until  some  little  time 
afterward.  It  might  happen,  for  instance,  that  a 
cotton  manufacturing  firm  in  France  wanted  to 
import  a  lot  of  raw  cotton  from  the  United  States, 
but  did  not  want  to  be  drawn  upon  at  the  time. 
Under  such  circumstances  the  American  house 
might  ship  the  goods  and  send  over  the  documents 
to  the  buyer,  postponing  its  drawing  for  some 
time.  Eventually,  of  course,  the  American  house 
would  reimburse  itself  by  drawing,  but  the  docu- 
ments having  gone  forward  long  before,  the 
drafts  would  be  what  is  known  as  "clean." 

Later  on,  in  the  chapter  on  the  actual  money- 
making  operations  of  the  foreign  department,  the 
risk  in  buying  various  kinds  of  bills  will  be  fully 
explained,  but  in  passing  it  may  be  mentioned 
that  "clean"  bills  are  of  such  a  nature  that  bank- 
ers will  touch  them  only  when  drawn  by  the  very 
best  houses.  With  a  documentary  bill,  the  banker 
holds  the  bill  of  lading,  and  if  there  is  any  trouble 
about  the  acceptance  or  payment  of  a  draft,  can 
simply  seize  the  goods  and  sell  them.  But  in  the 
case  of  a  "clean"  bill,  he  has  absolutely  no  secur- 
ity. The  standing  of  the  maker  of  the  bill  and 
what  he  knows  about  the  maker's  right  to  draw 


52  FOREIGN    EXCHANGE 

the  bill  is  all  he  has  to  go  by  in  determining 
whether  to  buy  it  or  not. 

/&/    Documentary  Commercial  Bills  Drawn  at 

Short  Sight 

A  comparatively  small  part  of  our  exports  are 

sold  on  a  basis  where  the  draft  drawn  is  at  less 

than  thirty  days'  sight,  but  there  are  a  good  many 


/u^a.   %**sH*eCi*seC  gg^g  ,^^**V,  <^**>*-<<g  /&£l-£^f 


aSQa*  *>jS«-  rf       •  A^~^C- 

Form  of  Documentary  Commercial  Sight  Bill 

small  bills  of  this  kind  continually  coming  into 
the  market.  Drafts  drawn  against  manufactured 
articles  and  against  such  products  as  cheese,  but- 
ter, dried  fruits,  etc.,  are  apt  to  be  drawn  for, 
with  shipping  documents  attached,  at  anywhere 
from  three  to  thirty  days'  sight,  but  there  is  no 
rule  about  it.  Where  the  "usance" — the  time  the 
bill  has  to  run — is  only  a  few  days,  documents  are 
apt  to  be  deliverable  only  on  payment  of  the  bills. 


FOREIGN    EXCHANGE  53 

Drafts  Drawn  Against  Securities 

Exchange  of  this  kind  is  naturally  of  the  high- 
est class,  the  stocks  or  bonds  against  which  it  is 
drawn  being  almost  always  attached  to  the  bill  of 
exchange.  In  the  case  of  syndicate  participations 
by  large  houses,  the  bonds  may  be  shipped  abroad 


Form  of  Draft  Drawn  Against  Securities 

privately  and  exchange  against  them  drawn  and 
sold  independently,  in  which  case,  of  course,  no 
security  is  attached,  but  as  a  rule  the  bonds  or 
stocks  go  with  the  draft.  A,  in  New  York,  exe- 
cutes an  order  to  buy  for  B  in  London,  one  hun- 
dred Union  Pacific  preferred  shares  on  the  New 
York  Stock  Exchange.  The  stock  comes  into 
A's  office,  and  he  pays  for  it  with  the  proceeds  of 
a  sterling  draft  he  draws  on  B.  The  stock  itself 
he  attaches  to  this  sterling  draft.  Whoever  buys 
the  draft  of  him  gets  the  stock  with  it  and  keeps 


54  FOREIGN    EXCHANGE 

possession  of  it  till  the  draft  is  presented  and  paid 
in  London. 

(5)    Bankers'  Checks  or  Demand  Drafts  on  Their 
Correspondents  Abroad 

Bankers  who  do  a  foreign  exchange  business, 
keeping  large  balances  in  several  European  cen- 
ters, are  continually  drawing  and  selling  their  de- 
mand drafts — "checks,"  they  are  called,  or  "de- 


Form  of  Bankers'  Check 


mand" — upon  these  foreign  balances.  Such 
checks  are  always  to  be  had  in  great  volume  in 
the  exchange  market,  the  banker's  business  being 
to  draw  and  sell  exchange,  and  his  degree  of  will- 
ingness being  merely  a  matter  of  rate.  There 
come  times,  of  course,  when  bankers  have  every 
reason  to  leave  their  foreign  balances  undisturbed, 
but  even  at  such  times  the  bid  of  a  high  enough 
rate  will  usually  bring  about  the  drawing  of  bills. 


FOREIGN    EXCHANGE  55 

C.     Bankers'  Long  Drafts 

In  describing  the  nature  of  bankers'  drawings 
of  long  bills,  great  care  must  be  taken  to  differen- 
tiate between  the  different  kinds  of  long  bills  be- 
ing bought  and  sold  in  the  exchange  market.    A 

Guaranty Trust  Company  of  New  York 

J^i*^Z7      ■        s/s,..u.i  srX&>.*/ &*?■  shz-m/a  First 

/V      <ni£4..  f-  (£>  '        - "  ' 

Guaranty  Trust  Co.ofNewYork. 

.  "^y    .     *■  i?         -/•  (  ■ 

No.JLo;iQ»__    «*""— v  ^y — -l     ZS^^r 

Form  of  Bankers'  Long  Draft 

finance  bill  looks  exactly  the  same  as  a  long  bill 
drawn  by  a  banker  for  a  commercial  customer 
who  wants  to  anticipate  the  payment  abroad  for 
an  incoming  shipment  of  wool  or  shellac,  but 
the  nature  and  origin  of  the  two  bills  are  radically 
different.  The  three  main  kinds  of  bankers'  long 
bills  will  thus  be  taken  up  in  the  following  order : 

A.     Bills  Drawn  in  the  Regular  Course  of  Busi- 
ness 
Such  is  the  nature  of  foreign  exchange  busi- 
ness that  bankers  engaged  in  it  are  continually 


56  FOREIGN    EXCHANGE    . 

drawing  their  sixty  and  ninety  days'  sight  bills  in 
response  to  their  own  and  their  customers'  needs. 
One  example  which  might  be  cited  is  that  of  the 
importer  who  has  a  payment  to  make  on  the  other 
side,  sixty  days  from  now,  but  who,  having  the 
money  on  hand,  wants  to  make  it  at  once.  Under 
some  circumstances  such  an  importer  might  remit 
a  demand  draft  on  the  basis  of  receiving  a  rebate 
of  interest  for  the  unexpired  sixty  days,  but  more 
likely  he  would  go  to  a  banker  and  buy  from  him 
a  sixty  days'  sight  draft  for  the  exact  amount  of 
pounds  he  owed.  The  cost  of  such  a  draft — ■ 
which  would  mature  at  the  time  the  debt  became 
due — would  be  less  than  the  cost  of  a  demand 
draft,  the  importer  getting  his  rebate  of  interest 
out  of  the  cheaper  price  he  pays  for  the  pounds 
he  needs.  Prepayments  of  this  sort  are  responsi- 
ble every  day  for  very  large  drawings  of  bankers' 
long  bills. 

B.     Long  Bills  Issued  in  the  Operation  of  Lend- 
ing Foreign  Money 

Bills  of  this  kind  represent  by  far  the  greater 
proportion  of  bankers'  long  bills  sold  in  the  ex- 
change market.  European  bankers  keep  an  enor- 
mous amount  of  floating  capital  loaned  out  in 


FOREIGN    EXCHANGE  57 

this  market,  in  the  making  and  renewing  of  which 
loans  long  bills  are  created  as  follows : 

A  banker  on  the  other  side  decides  to  loan  out, 
say,  £100,000  in  the  New  York  market.  Ar- 
rangements having  been  made,  he  cables  his  New 
York  representative  to  draw  ninety  days'  sight 
drafts  on  him  for  £100,000,  the  proceeds  of  which 
drafts  are  then  loaned  out  for  account  of  the  for- 
eign house.  The  matter  of  collateral,  risk  of  ex- 
change and,  indeed,  all  the  other  detail,  will  be 
fully  described  in  the  succeeding  chapters  on  how 
bankers  make  money  out  of  exchange.  For  the 
time  being  it  is  merely  necessary  to  note  that  every 
time  a  loan  of  foreign  capital  is  made  here — and 
there  are  days  when  millions  of  pounds  are  so 
loaned  out — bankers'  long  bills  for  the  full 
amount  of  the  loans  are  created  and  find  their 
way  into  the  exchange  market. 

C.     Bankers'  Long  Bills  Drawn  for  the  Purpose 
of  Raising  Money 

Finance  bills  constitute  the  third  kind  of  bank- 
ers' long  exchange.  In  this  case,  again,  detailed 
discussion  must  be  put  off  until  the  chapter  on 
foreign-exchange-bankers'  operations,  but  the 
fact  that  bills  of  this  kind  constitute  so  important 


58  FOREIGN    EXCHANGE 

a  part  of  the  bankers'  long  bills  to  be  had  in  the 
market,  necessitates  their  classification  in  this 
place.  Every  time  a  banker  here  starts  to  use  his 
credit  abroad  for  the  purpose  of  raising  money — 
and  there  are  times  when  the  privilege  is  pretty 
freely  availed  of — he  does  it  by  drawing  sixty  or 
ninety  days'  sight  drafts  on  his  correspondents 
abroad.  Finance  bills,  it  may  be  said  without 
question,  are  one  of  the  most  interesting  forms  of 
foreign  exchange  banking — at  the  same  time  one 
of  the  most  useful  and  one  of  the  most  abused  of 
privileges  coming  to  the  domestic  banker  by  rea- 
son of  his  having  strong  banking  connections 
abroad. 


CHAPTER    V 

THE  FOREIGN  EXCHANGE  MARKET 

THE  foreign  exchange  market  is  in  every 
sense  "open" — anyone  with  bills  to  buy  or 
sell  and  whose  credit  is  all  right  can  enter 
it  and  do  business  on  a  par  with  anyone  else. 
There  is  no  place  where  the  trading  is  done,  no 
membership,  license  or  anything  of  the  kind.  The 
"market,"  in  fact,  exists  in  name  only;  it  is  really 
constituted  of  a  number  of  banks,  dealers  and 
brokers,  with  offices  in  the  same  section  of  the  city, 
and  who  do  business  indiscriminately  among 
themselves — sometimes  personally,  sometimes  by 
telephone,  by  messenger,  or  by  the  aid  of  the  con- 
tinuously circulating  exchange  brokers. 

The  system  is  about  as  follows:  The  larger 
banks  and  banking  houses  have  a  foreign  ex- 
change manager,  or  partner,  taking  care  of  that 
part  of  the  business,  whose  office  is  usually  so 
situated  as  to  make  him  accessible  to  the  brokers 
who  come  in  from  the  outside,  and  whose  tele- 
phoning and  wiring  facilities  are  very  complete. 
These  larger  houses  have  no  brokers  or  "outside" 
men  in  their  employ.  The  manager  knows  very 
well  that  plenty  of  chance  to  do  business,  buying 

50 


60  FOREIGN    EXCHANGE 

or  selling,  will  be  brought  in  to  him  by  the  brokers 
and  that  his  wires  keep  him  constantly  in  touch 
with  his  fellow  bankers. 

Next  come  the  big  dealers  in  exchange,  some  of 
whom  do  a  regular  exchange  business  of  their 
own,  the  same  as  the  bankers,  but  who  also  have 
men  out  on  the  street  "trading"  between  large 
buyers  and  sellers  of  bills.  Such  houses  are  nec- 
essarily closely  in  touch  with  banks,  bankers,  ex- 
porters, and  importers  all  over  the  country,  and 
have  always  large  orders  on  hand  to  buy  and  sell 
exchange.  Some  of  the  bills  they  handle  they  buy 
and  use  for  the  conduct  of  their  own  business  with 
banks  abroad,  but  the  more  important  part  of 
what  they  do  is  to  deal  in  foreign  exchange 
among  the  banks.  They  are  known  as  always 
having  on  hand  for  sale  large  lines  of  commercial 
and  bankers'  bills,  while  on  the  other  hand  they 
are  always  ready  to  buy,  at  the  right  price. 

After  this  class  of  houses  come  the  regular 
brokers — the  independent  and  unattached  indi- 
viduals who  spend  their  time  trying  to  bring 
buyer  and  seller  together,  and  make  a  commission 
out  of  doing  it.  In  a  market  like  New  York  the 
number  of  exchange  brokers  is  very  large.  Like 
bond-brokerage,  the  business  requires  little  in  the 
way  of  office  facilities  or  capital,  and  is  attractive 


FOREIGN    EXCHANGE  61 

to  a  good  many  persons  who  are  willing  to  accept 
the  small  income  to  be  made  out  of  it  in  return  for 
being  in  a  business  where  they  are  independent. 

Foreign  exchange  brokerage,  like  all  other  em- 
ployment of  the  middleman,  is  not  what  it  used 
to  be.  Before  the  business  became  overcrowded 
as  it  is  now,  exchange  brokers  made  their  quarter- 
cent  in  the  pound  commission,  and  could  depend 
on  a  respectable  income.  But  nowadays  brokers 
swarm  among  the  foreign  exchange  bankers  and 
dealers,  doing  business  on  any  commission  they 
can  get,  which  is  not  infrequently  as  little  as 
1-128  of  one  per  cent.,  say,  $1.50,  for  buying  or 
selling  francs  100,000.  In  handling  sterling,  the 
broker  is  lucky  if  he  makes  his  five  points  (5-100 
of  a  cent  per  pound) ,  which  means  that  for  turn- 
ing over  £10,000  he  would  be  rewarded  with  the 
sum  of  $5.  Under  such  conditions  it  is  not  diffi- 
cult to  see  how  hard  it  is  to  make  any  money  to 
speak  of  out  of  foreign  exchange  brokerage. 

The  dealers,  of  course,  fare  much  better.  Han- 
dling commercial  bills  where  the  question  of 
credit  affects  the  price,  they  have  a  chance  to 
make  more  of  a  profit,  and  buying  and  selling 
bills  for  their  own  account  they  naturally  are  en- 
titled to  make  more  than  the  man  without  capital, 
who  simply  tries  to  get  in  between  the  buyer  and 


62  FOREIGN    EXCHANGE 

the  seller.  Dealing  in  exchange,  especially  for 
out-of-town  clients,  is  a  highly  profitable  business, 
but  one  which  takes  time,  brains,  experience  and 
money  to  build  up.  Dealers  representing  large 
out-of-town  sellers  of  exchange  are  very  much  in 
the  position  of  the  New  York  agents  of  manufac- 
turing companies  who  sell  goods  on  commission. 
There  being  no  regular  market  in  which  foreign 
exchange  rates  are  made,  it  follows  that  the  es- 
tablishment of  rates  each  morning  and  during  the 
course  of  each  day  will  be  according  to  the  supply 
and  demand  for  bills.  On  any  given  morning  by 
ten  o'clock  the  bankers  will  all  have  received  their 
cables  quoting  money  and  exchange  rates  in  the 
foreign  centers,  and  will  all  have  pretty  well  made 
up  their  minds  as  to  what  the  rate  for  demand 
bills  on  London  ought  to  be.  A  banker,  for  in- 
stance, has  £10,000  he  wants  to  sell  as  early  in  the 
morning  as  possible,  and  from  his  foreign  cables 
figures  that  4.86  is  about  the  right  price.  He 
offers  it  at  that,  but  learns  that  another  banker 
is  offering  exchange  at  4.8595.  He  offers  his  own 
at  that  price,  and  somebody  comes  along,  taking 
both  lots  and  bidding  4.86  for  £50,000  more. 
Somebody  else  bids  4.86  for  other  large  lots,  re- 
fusing, however,  to  pay  4.8605.  The  market  is 
established  at  that  point. 


FOREIGN    EXCHANGE  63 

For  the  time  being.  A  cable  message  from 
abroad  may  induce  some  banker  to  bid  4.8605  or 
4.8610,  or  it  may  cause  him  to  throw  on  the  mar- 
ket such  an  amount  of  exchange  as  may  break  the 
price  down  to  4 . 85%.  Rates  are  constantly  chang- 
ing, and  changing  at  times  almost  from  minute  to 
minute.  Yet  so  complete  is  the  system  of  tele- 
phones and  brokers  that  any  exchange  manager 
can  tell  just  about  what  is  taking  place  in  any 
other  part  of  the  market.  Not  infrequently,  of 
course,  sales  are  made  simultaneously  at  slightly 
different  rates,  but,  as  a  rule,  if  a  trade  is  made  at 
4.86  on  Cedar  Street,  4.86  will  be  the  rate  on  Ex- 
change Place.  It  is  remarkable  how  closely  each 
manager  keeps  in  touch  with  what  is  going  on  in 
every  part  of  the  market.  And  the  great  number 
of  brokers  continually  circulating  around  and  try- 
ing to  "get  in  between"  for  five  points  is  in  itself 
a  powerful  influence  toward  keeping  rates  ex- 
actly the  same  in  all  parts  of  the  market  at  once. 

"Posted  rates"  mean  little  with  regard  to  cur- 
rent conditions,  being  simply  the  bankers'  public 
notice  of  the  rate  at  which  he  will  sell  bills  for 
trifling  amounts.  Exchange  bankers  dislike  to 
draw  small  drafts  and  usually  can  be  induced  to 
do  so  only  by  the  offer  of  a  much  higher  rate  than 
that  current  for  a   large   amount.     A  banker 


64  FOREIGN    EXCHANGE 

might  offer  to  sell  you  £10,000  at  4.87,  but  if  you 
said  you  wanted  only  £10,  he  would  be  likely  to 
point  to  his  posted  rate  and  charge  you  4.88. 
Considering  that  in  transactions  based  on  the  best 
bills  the  banker  only  figures  on  making  from  $10 
to  $20  profit  on  each  £10,000,  it  may  readily  be 
seen  why  he  is  not  anxious  to  sell  a  £10  draft. 

As  to  the  actual  fluctuation  of  exchange,  while 
it  is  true  that  rates  at  times  rise  and  fall  with  all 
the  violence  so  often  displayed  in  the  security 
markets,  most  of  the  time  they  move  within  a 
comparatively  narrow  range.  On  an  ordinary 
business  day,  for  instance,  the  change  is  not  apt  to 
run  over  fifteen  points  (15-100  of  a  cent  per 
pound).  In  the  morning,  demand  sterling  may 
be  at,  say,  4.86;  at  noon  a  moderate  demand  for 
bills  may  carry  the  rate,  first,  to  4.8605,  then  to 
4.8610;  and  finally,  perhaps,  to  4.8615.  On  fairly 
large  offerings  of  bills  the  market  might  then 
recede  to,  say,  4.8605,  ending  the  day  five  points 
up.  And  that  would  be  an  ordinary  day — by  no 
means  the  kind  of  a  day  the  exchange  market  al- 
ways sees,  but  a  day  corresponding  to  a  stock 
market  session  in  which  the  market  leaders  rise  or 
fall  a  point  or  so. 

There  are  times,  of  course,  when  very  different 
conditions  prevail.     An  unexpected  rise  in  the 


FOREIGN    EXCHANGE  65 

bank  rate  in  London,  the  announcement  of  a  big 
loan  or  any  one  of  many  different  happenings,  are 
apt  to  cause  a  reduction  in  the  exchange  market 
and  a  bewildering  movement  of  rates  up  and 
down.  At  such  times  a  rise  or  fall  of  fifty  points 
in  sterling  within  half  an  hour  is  not  at  all  out  of 
the  ordinary,  while  in  times  of  panic,  or  when 
great  crises  impend,  the  fluctuations  will  be  three 
or  four  times  as  great.  During  the  latter  part  of 
October,  1907,  and  in  November,  the  exchange 
market  fluctuated  with  greater  violence  than,  per- 
haps, at  any  other  time  since  the  gold  standard 
was  firmly  established.  Thrown  completely  out 
of  gear  by  the  premium  of  3%  per  cent,  a  day  for 
currency  during  the  panic  time,  the  exchange 
markets  for  some  time  would  rise  and  fall  several 
cents  in  the  pound  on  the  same  day.  Completely 
baffled  by  this  erratic  movement,  many  bankers 
temporarily  withdrew  entirely  from  the  market. 
As  to  the  relative  importance  of  the  different 
kinds  of  exchange,  sterling,  of  course,  occupies 
the  most  prominent  position.  What  proportion 
of  the  total  of  exchange  dealt  in  in  the  New  York 
market  consists  of  sterling  it  is  impossible  to  de- 
termine, but  that  it  is  as  great  as  the  volume  of  all 
the  other  kinds  of  exchange  put  together  can 
safely  be  said.  Many  big  dealers,  indeed,  make  a 


66  FOREIGN    EXCHANGE 

specialty  of  sterling,  and  if  they  handle  any  other 
bills  at  all,  do  so  only  on  a  very  small  scale.  As 
to  whether  francs  or  marks  come  next  in  volume, 
there  is  a  difference  of  opinion.  With  Germany 
our  direct  financial  transactions  are  probably  con- 
siderably larger  than  with  France,  but  the  posi- 
tion of  Paris  as  a  banking  centre  makes  the 
French  capital  figure  prominently  in  many  op- 
erations where  the  French  market  is  not  directly 
concerned.  Despite  the  fact  that  sterling  easily 
predominates,  the  volume  of  franc  and  mark  bills, 
too,  is  enormous.  Drafts  on  Paris  for  from  three 
to  five  million  francs  and  on  Berlin  for  as  many 
marks  are  not  at  all  infrequently  traded  in  in  the 
exchange  market,  and  at  times  bills  for  very 
much  larger  amounts  have  been  drawn  and  of- 
fered for  sale. 

Bills  drawn  in  other  kinds  of  currency — 
guilders  on  Holland,  for  instance,  form  an  im- 
portant part  of  the  foreign  exchange  dealt  in  in  a 
market  like  New  York,  but  are  subservient  in 
their  rate  fluctuations  to  the  movement  of  ster- 
ling, marks,  and  francs.  The  latter  are,  indeed, 
the  three  great  classes  of  exchange,  and  are  the 
basis  of  at  least  nine-tenths  of  all  foreign  ex- 
change operations. 

In  the  following  chapter  will  be  taken  up  the 


FOREIGN    EXCHANGE  67 

various  forms  of  activity  of  the  foreign  exchange 
department.  No  attempt  is  made  to  state  out  of 
which  kind  of  business  bankers  make  most  money, 
but  before  looking  into  the  more  detailed  descrip- 
tion of  how  exchange  business  is  conducted,  it 
may  be  well  to  fix  in  mind  the  fact  that  it  is  out  of 
the  "straight"  forms  of  foreign  exchange  business 
that  the  most  profit  is  made.  Highly  complicated 
operations  are  indulged  in  by  some  managers  with 
more  theoretical  than  practical  sense,  and  money 
is  at  times  made  out  of  them,  but  on  the  whole  the 
real  money  is  made  out  of  the  kinds  of  business 
about  to  be  described.  To  the  author's  certain 
knowledge,  the  exchange  business  of  one  of  the 
largest  houses  in  New  York  was  for  years  thus 
limited  to  what  might  be  called  "straight"  opera- 
tions. While  the  profits  might  at  times  have  been 
materially  increased  by  the  introduction  of  a  little 
more  of  a  speculative  element  into  the  business, 
the  house  made  money  on  a  large  scale  and 
avoided  the  losses  inevitable  where  business  is  con- 
ducted along  speculative  lines. 


CHAPTER    VI 

HOW  MONEY  IS  MADE  IN  FOREIGN 
EXCHANGE.     THE  OPERATIONS 
OF   THE   FOREIGN   DEPART- 
MENT 

COMPLETE  description  of  the  various 
forms  of  activity  of  the  foreign  exchange 
department  of  an  important  firm  would 
fill  a  large  volume,  but  there  are  certain  stock 
operations  in  foreign  exchange  which  are  the 
basis  of  most  of  the  transactions  carried  out  and 
the  understanding  of  which  ought  to  go  a  long 
way  toward  making  clear  what  the  nature  of  the 
foreign  exchange  department's  business  really  is. 

1.     Selling  "Demand"  Against  "Demand  " 

The  first  and  most  elementary  form  of  activity 
is,  of  course,  the  buying  of  demand  bills  at  a  cer- 
tain price  and  the  selling  of  the  banker's  own  de- 
mand drafts  against  them  at  a  higher  price.  A 
banker  finds,  for  instance,  that  he  can  buy  John 
Smith  &  Co.'s  sight  draft  for  £1,000,  on  London, 
at  the  rate  of  4.86,  and  that  he  can  sell  his  own 
draft  for  £1,000  on  his  London  banking  corre- 

68 


FOREIGN    EXCHANGE  69 

spondent  at  4.87.  All  he  has  to  do,  therefore,  is 
to  bu^  John  Smith's  draft  for  $4,860,  send  it  to 
London  for  credit  of  his  account  there,  and  then 
draw  his  own  draft  for  £1,000  on  the  newly  cre- 
ated balance,  selling  it  for  $4,870.  It  cost  him 
$4,860  to  buy  the  commercial  draft,  and  he  has 
sold  his  own  draft  against  it  for  $4,870.  His 
gross  profit  on  the  transaction,  therefore,  is  $10. 

As  may  be  imagined,  not  very  much  money  is 
made  in  transactions  exactly  of  this  kind — the 
one  cited  is  taken  only  because  it  illustrates  the 
principle.  For  whether  the  banker  sends  over  in 
every  mail  a  bewildering  assortment  of  every  con- 
ceivable form  of  foreign  exchange  to  be  credited 
to  his  account  abroad,  or  whether  he  confines  him- 
self to  remittances  of  the  simplest  kinds  of  bills, 
the  idea  remains  exactly  the  same — he  is  deposit- 
ing money  to  the  credit  of  his  account  in  order 
that  he  may  have  a  balance  on  which  he  can  draw. 
That  is,  indeed,  the  sum  and  substance  of  the  ex- 
change business  of  the  foreign  department  of 
most  banking  houses — the  maintaining  of  deposit 
accounts  in  banks  at  foreign  centers  on  which  de- 
posit account  the  bank  here  is  in  a  position  to 
draw  according  to  the  wants  and  needs  of  its  cus- 
tomers. 

To  analyze  the  underlying  transaction  a  little 


70  FOREIGN    EXCHANGE 

more  closely,  it  is  evident  that  the  banker,  in  or- 
der to  make  a  profit,  must  be  able  to  buy  the  com- 
mercial bill  at  a  lower  rate  of  exchange  than  he 
can  realize  on  his  own  draft.  Which  suggests  at 
once  that  the  extent  of  the  banker's  profit  is  de- 
pendent largely  upon  the  amount  of  risk  he  is 
willing  to  take.  For  the  rate  on  commercial  bills 
is  purely  a  matter  of  the  drawer's  credit.  The 
best  documentary  commercial  exchange,  drawn 
at  sight  on  banks  abroad  or  houses  of  the  highest 
standing  will  command  a  rate  of  exchange  in  the 
open  market  only  a  little  less  than  the  banker's 
own  draft.  From  which  point  the  rate  realizable 
on  commercial  bills  tapers  off  with  the  credit  of 
the  house  in  question,  some  bills  regularly  selling 
a  cent  or  a  cent  and  a  half  per  pound  sterling  be- 
low the  best  bills  of  their  class. 

Without  the  introduction,  therefore,  of  the  ele- 
ment of  speculation,  except  as  to  the  soundness  of 
the  bills'  makers,  it  is  possible  for  bankers  to  make 
widely  varying  profits  out  of  the  same  kind  of 
business.  Everything  depends  upon  the  amount 
of  risk  the  banker  is  willing  to  take.  The  ex- 
change market  is  a  merciless  critic  of  credit,  and 
if  a  commercial  firm's  bills  always  sell  at  low 
rates,  the  presumption  is  strongly  against  its 
financial  strength.    Cases  very  frequently  occur, 


FOREIGN    EXCHANGE  71 

however,  where  the  exchange  market  misjudges 
the  goodness  of  a  bill,  placing  too  low  a  valuation 
upon  it.  In  that  case  the  banker  who,  individ- 
ually, knows  that  the  house  in  question  is  all 
right,  can  make  considerable  sums  of  money  buy- 
ing its  bills  at  the  low-going  rates  and  selling  his 
own  exchange  against  them.  This,  evidently,  is 
purely  a  matter  of  the  exchange  manager's  judg- 
ment. With  comparatively  little  risk  there  are 
banking  houses  which  are  making  a  full  cent  a 
pound  out  of  a  good  part  of  the  commercial  ex- 
change they  handle. 

2.     Selling  Cables  Against  Demand  Exchange 

No  description  of  a  cable  transfer  having  been 
given  in  the  preceding  description  of  different 
kinds  of  exchange,  it  may  be  explained  briefly 
that  a  "cable,"  so-called,  differs  from  a  sight 
draft  only  in  that  the  banker  abroad  who  is  to  pay 
out  the  money  is  advised  to  do  so  by  means  of  a 
telegraphic  message  instead  of  by  a  bit  of  paper 
instructing  him  to  "pay  to  the  order  of  so  and  so." 
A,  in  New  York,  wants  to  transfer  money  to  B,  in 
London.  He  goes  to  his  banker  in  New  York 
and  deposits  the  amount,  in  dollars,  with  him,  re- 
questing that  he  (the  New  York  banker)  instruct 
his  correspondent  in  London,  by  cable,  to  pay  to 


72  FOREIGN    EXCHANGE 

B  the  equivalent  in  pounds.  The  transfer  is  im- 
mediate, the  cable  being  sent  as  soon  as  the  Amer- 
ican banker  receives  the  money  on  this  end. 

To  be  able  to  instruct  its  correspondent  in  Lon- 
don by  cable  to  pay  out  large  sums  at  any  given 
time,  a  bank  here  must  necessarily  carry  a  sub- 
stantial credit  balance  abroad.  It  would  be  pos- 
sible, of  course,  for  a  banker  to  instruct  his  Lon- 
don agent  by  cable  to  pay  out  a  sum  of  money,  at 
the  same  time  cabling  him  the  money  to  pay  out, 
but  this  operation  of  selling  cables  against  cables 
is  not  much  indulged  in — there  is  too  little 
chance  of  profit  in  it.  Under  special  circum- 
stances, however,  it  can  be  seen  that  a  house  anx- 
ious to  sell  a  large  cable  and  not  having  the  bal- 
ance abroad  to  do  it,  might  easily  provide  its  cor- 
respondent abroad  with  the  funds  by  going  out 
and  buying  a  cable  itself. 

But  under  ordinary  circumstances  foreign  ex- 
change dealers  who  engage  in  the  business  of  sell- 
ing cables  carry  adequate  balances  on  the  other 
side,  balances  which  they  keep  replenishing  by 
continuous  remittances  of  demand  exchange. 
Which  in  itself  constitutes  an  important  form  of 
foreign  exchange  activity  and  an  operation  out 
of  which  many  large  houses  make  a  good  deal  of 
monev. 


FOREIGN    EXCHANGE  73 

All  the  parties  involved  being  bankers  there  is 
little  risk  in  business  of  this  kind ;  but,  on  the  other 
hand,  the  margin  of  profit  is  small,  and  in  order  to 
make  any  money  out  of  it,  it  is  necessary  that 
very  large  amounts  of  money  be  turned  over.  The 
average  profit,  for  instance,  realized  in  the  New 
York  exchange  market  from  straight  sales  of 
cables  against  remittances  of  checks  is  fifteen 
points  (15-100  of  a  cent  per  pound  sterling). 
That  means  that  on  every  £10,000,  the  gross 
profit  would  be  $15.00.  A  daily  turnover  of 
£50,000,  therefore,  would  result  in  a  gross  profit 
of  $75  a  day. 

It  may  seem  strange  that  bankers  should  be 
willing  to  turn  over  so  large  an  amount  of  money 
for  so  small  a  profit,  even  where  the  risk  has  been 
reduced  to  a  minimum,  but  that  is  the  case.  Very 
often  cables  are  sold  against  balances  which  have 
been  accumulated  by  remittance  of  all  sorts  of 
bills  other  than  demand,  but  there  are  several 
large  American  institutions  whose  foreign  ex- 
change business  consists  principally  of  the  regula- 
tion selling  of  cables  against  remittances  of  de- 
mand bills.  By  reason  of  their  large  deposits  they 
are  in  a  position  to  carry  full  balances  abroad, 
while  in  the  course  of  their  regular  business  a 
good  deal  of  sight  exchange  of  high  class  comes 


74  FOREIGN    EXCHANGE 

across  their  counters.  All  the  necessary  elements 
for  doing  the  business  being  there,  it  only  re- 
mains for  such  an  institution  to  employ  a  man 
capable  of  directing  the  actual  transactions.  The 
risk  is  trifling,  the  advertisement  is  world-wide, 
the  accommodation  of  customers  is  being  attended 
to,  and  there  is  considerable  actual  money  profit 
to  be  made.  The  business  in  many  respects  is 
thus  highly  desirable. 

3.    Selling  tfDe?nand"  Bills  Against  Remittances 
of  Long  Bills 

If  there  is  a  stock  operation  in  the  conduct  of  a 
foreign  exchange  business  it  is  the  selling  by 
bankers  of  their  demand  bills  of  exchange  against 
remittances  of  commercial  and  bankers'  long 
paper.  Bills  of  the  latter  class,  as  has  been 
pointed  out,  make  up  the  bulk  of  foreign  ex- 
change traded  in,  and  its  disposal  naturally  is  the 
most  important  phase  of  foreign  exchange  busi- 
ness. For  after  all,  all  cabling,  arbitraging  in  ex- 
change, drawing  of  finance  bills,  etc.,  is  only  inci- 
dental. What  the  foreign  exchange  business  really 
is  grounded  on  is  the  existence  of  commercial  bills 
called  into  existence  by  exports  of  merchandise. 

There  are  houses  doing  an  extensive  exchange 


FOREIGN    EXCHANGE  75 

business  who  never  buy  commercial  long  bills, 
but  the  operations  they  cany  on  are  made  pos- 
sible only  by  the  fact  that  most  other  houses  do. 
A  foreign  exchange  department  which  does  not 
handle  this  kind  of  exchange  is  necessarily  on 
the  "outside"  of  the  real  business — is  like  a  bond 
broker  who  does  not  carry  bonds  with  his  own 
money  but  merely  trades  in  and  out  on  other 
people's  operations. 

Buying  and  remitting  commercial  long  bills  is, 
however,  no  pastime  for  an  inexperienced  man. 
Entirely  aside  from  the  question  of  rate,  and 
profit  on  the  exchange  end  of  the  transaction, 
there  must  be  taken  into  consideration  the  matter 
of  the  credit  of  the  drawer  and  the  drawee,  the 
salability  of  the  merchandise  specified  in  the  bill 
of  lading,  and  a  number  of  other  important 
points.  This  question  of  credit,  underlying  to 
so  great  a  degree  the  whole  business  of  buying 
commercial  long  paper,  will  be  considered  first. 

The  completely  equipped  exchange  department 
has  at  its  disposal  all  the  machinery  necessary 
for  investigating  expeditiously  the  standing  and 
financial  strength  of  any  firm  whose  bills  are  like- 
ly to  be  offered  in  the  exchange  market.  Such 
facilities  are  afforded  by  subscription  to  the  two 
leading  mercantile  agencies,  but  in  addition  to 


76  FOREIGN    EXCHANGE 

this,  the  experienced  exchange  manager  has  at  his 
command  private  sources  of  information  which 
can  be  applied  to  practically  every  firm  engaged 
in  the  export  business.  The  larger  banks,  of 
course,  all  have  a  regular  credit  man,  one  of  whose 
chief  duties  nowadays  is  to  assist  in  the  handling 
of  the  bank's  foreign  exchange  business.  So  per- 
fect does  the  organization  become  after  a  few 
years  of  the  actual  transaction  of  a  foreign  ex- 
change business  that  the  standing  of  practically 
any  bill  taken  by  a  broker  into  a  bank,  for  sale, 
can  be  passed  upon  instantly.  New  firms  come 
into  existence,  of  course,  and  have  to  be  fully  in- 
vestigated, but  the  experienced  manager  of  a  for- 
eign department  can  tell  almost  offhand  whether 
he  wants  a  bill  of  any  given  name  or  not. 

Where  documents  accompany  the  draft  and  the 
merchandise  is  formally  hypothecated  to  the  buy- 
er of  the  draft,  it  might  not  be  thought  that  the 
standing  of  the  drawer  would  be  of  such  great 
importance.  Possession  of  the  merchandise,  it  is 
true,  gives  the  banker  a  certain  form  of  security 
in  case  acceptance  of  the  bill  is  refused  by  the 
parties  on  whom  it  is  drawn  or  in  case  they  refuse 
to  pay  it  when  it  comes  due,  but  the  disposal  of 
such  collateral  is  a  burdensome  and  often  ex- 
pensive operation.  The  banker  in  New  York  who 


FOREIGN    EXCHANGE  77 

buys  a  sixty-day  draft  drawn  against  a  shipment 
of  butter  is  presumably  not  an  expert  on  the  but- 
ter market  and  if  he  should  be  forced  to  sell  the 
butter,  might  not  be  able  to  do  so  to  the  fullest 
possible  advantage.  Employment  of  an  expert 
agent  is  an  expensive  operation,  and,  moreover, 
there  is  always  the  danger  of  legal  complication 
arising  out  of  the  banker's  having  sold  the  col- 
lateral. It  is  desirable  in  every  way  that  if  there 
is  to  be  any  trouble  about  the  acceptance  or  pay- 
ment of  a  draft,  the  banker  should  keep  himself 
out  of  it. 

A  concrete  illustration  of  the  dangers  atten- 
dant upon  the  purchase  of  commercial  long  bills 
from  irresponsible  parties  is  to  be  found  in  what 
happened  a  few  years  ago  to  a  prominent  ex- 
change house  in  New  York.  This  house  had  been 
buying  the  bills  of  a  certain  firm  for  some  little 
time,  and  everything  had  gone  well.  But  one  day 
acceptance  of  a  bill  for  £2,000  was  refused  by 
the  party  abroad,  and  the  news  cabled  that  the 
bill  of  lading  was  a  forgery  and  that  no  such  ship- 
ment had  ever  been  made.  Wiring  hurriedly  to 
the  inland  city  in  which  was  located  the  firm  which 
drew  the  bill,  the  New  York  bank  received  the  re- 
ply that  both  partners  had  decamped.  What  had 
happened  was  that,  about  to  break  up,  the  "firm" 


78  FOREIGN    EXCHANGE 

had  drawn  and  sold  several  large  bills  of  ex- 
change, with  forged  documents  attached,  re- 
ceived their  money  for  them,  and  then  disap- 
peared. Neither  of  them  was  ever  apprehended, 
and  the  various  bankers  who  had  taken  the  ex- 
change lost  the  money  they  had  paid  for  it. 
Forgery  of  the  bill  of  lading  in  this  case  had  been 
a  comparatively  easy  matter,  the  shipment  pur- 
porting to  have  been  made  from  an  obscure  little 
cotton  town  in  the  South,  the  signature  of  whose 
railroad  agent  was  not  at  all  known. 

This  forgery  is  only  one  example  of  the  trick- 
ery possible  and  the  extreme  care  which  is  neces- 
sary in  the  purchase  of  bills  of  this  kind.  And 
not  only  must  the  standing  of  the  drawer  be 
taken  into  consideration,  but  the  standing  of  the 
drawee  is  a  matter  of  almost  equal  importance — 
after  the  "acceptance"  of  the  bill,  the  parties  ac- 
cepting it  being  equally  liable  with  its  maker. 
The  nature  of  the  merchandise,  furthermore,  and 
its  marketability  are  further  considerations  of 
great  importance.  Cotton,  it  will  readily  appear, 
is  an  entirely  different  sort  of  collateral  from 
clocks,  or  some  specialty  in  which  the  market  may 
vary  widely.  The  banker  who  holds  a  bill  of 
lading  for  cotton  shipped  to  Liverpool  can  at  any 
moment  tell  exactly  what  he  can  realize  on  it.    In 


FOREIGN    EXCHANGE  79 

the  case  of  many  kinds  of  articles,  however,  the 
invoice  value  may  differ  widely  from  the  realiz- 
able value,  and  if  the  banker  should  ever  be 
forced  to  sell  the  merchandise,  he  might  have  to 
do  so  at  a  big  loss. 

Returning  to  the  actual  operation  of  selling 
bankers'  demand  against  remittances  of  long  bills, 
it  appears  that  the  successive  steps  in  an  actual 
transaction  are  about  as  follows : 

The  banker  in  New  York  having  ascertained 
by  cable  the  rate  at  which  bills  "to  arrive"  in  Lon- 
don by  a  certain  steamer  will  be  discounted,  buys 
the  bills  here  and  sends  them  over,  with  instruc- 
tions that  they  be  immediately  discounted  and  the 
proceeds  placed  to  his  credit.  On  this  resulting 
balance  he  will  at  once  draw  his  demand  draft 
and  sell  it  in  the  open  market.  If,  from  selling 
this  demand  draft,  he  can  realize  more  dollars 
than  it  cost  him  in  dollars  to  put  the  balance  over 
there,  he  has  made  a  gross  profit  of  the  difference. 

To  illustrate  more  specifically:  A  banker  has 
bought,  say,  a  £1,000  ninety  days'  sight  prime 
draft,  on  London,  documents  deliverable  on  ac- 
ceptance. This  he  has  remitted  to  his  foreign  cor- 
respondent, and  his  foreign  correspondent  has 
had  it  stamped  with  the  required  "bill-stamp," 
has  had  it  discounted,  and  after  having  taken  his 


80  FOREIGN    EXCHANGE 

commission  out  of  the  proceeds,  has  had  them 
placed  to  the  credit  of  the  American  bank.  In 
all  this  process  the  bill  has  lost  weight.  It  ar- 
rived in  London  as  £1,000,  but  after  commis- 
sions, bill-stamps  and  ninety-three  days'  dis- 
count have  been  taken  out  of  it,  the  amount  is  re- 
duced well  below  £  1,000.  The  net  proceeds  go- 
ing to  make  up  the  balance  on  which  the  Ameri- 
can banker  can  draw  his  draft  are,  perhaps,  not 
over  £990.  He  paid  so-and-so  many  dollars  for 
the  £1,000  ninety-day  bill,  originally.  If  he  can 
realize  that  many  dollars  by  selling  a  demand 
draft  for  £990  he  is  even  on  the  transaction. 

No  attempt  will  be  made  in  this  little  book  to 
present  the  tables  by  which  foreign  exchange 
bankers  figure  out  profit  possibilities  in  opera- 
tions of  this  kind.  The  terms  obtainable  from 
foreign  correspondents  vary  so  widely  according 
to  the  standing  and  credit  of  the  house  on  this 
side  and  are  governed  by  so  many  different  in- 
fluences that  a  manager  must  work  out  each 
transaction  he  enters  according  to  the  conditions 
by  which  he,  particularly,  and  his  operations  are 
governed.  Such  calculations,  moreover,  are  all 
built  up  along  the  general  line  of  the  scheme  pre- 
sented below: 


FOREIGN    EXCHANGE  81 

Assume  that  the  rate  for  demand  bills  is  4.85,  that  dis- 
count in  London  is  3\2  per  cent,  and  that  the  amount  of 
the  long  bill  remitted  for  discount  and  credit  of  proceeds 
is  £100. 

The  various  expenses  are  as  follows: 
Commission  charged  by  the  banker  in 

London    1-40  per  cent.     $0.12 

Discount,  93  days   (3  days  of  grace) 

at  SY2  per  cent 4.S8 

English  Government  bill  stamp 1-20  per  cent.       0.24 

$4.74 

Total  charges  on  the  ninety  days'  sight  £100 
bill  amount  to  $4.74.  On  one  pound,  therefore, 
the  charge  would  be  $.0474.  From  which  it  is 
evident  that  each  pound  of  a  ninety-day  bill,  un- 
der the  conditions  given,  is  worth  $.0474  (=4.74 
cents)  less  than  each  pound  in  a  bankers'  demand 
bill.  From  which  it  is  evident  that  if  such  a  de- 
mand bill  were  sold  at  4.85  against  a  ninety-day 
bill  bought  at  4.8026  (found  by  subtracting  4.74 
cents  from  485  cents)  the  remitting  banker  would 
come  out  even  in  the  transaction. 

The  foregoing  has  been  introduced  at  the  risk 
of  confusing  the  lay  reader,  on  the  idea  that  all 
the  various  calculations  regarding  the  drawing  of 
"demand"  against  the  remitting  of  long  bills  are 
founded  on  the  same  general  principle,  and  that 

6 


82  FOREIGN    EXCHANGE 

where  it  is  desired  to  go  more  deeply  into  the  mat- 
ter the  correct  conditions  can  be  substituted.  Dis- 
count, of  course,  varies  from  day  to  day,  "pay- 
ment" bills  do  not  go  through  the  discount  mar- 
ket at  all,  but  are  "rebated,"  the  commissions 
charged  different  bankers  and  by  different  bank- 
ers vary  widely.  Under  the  circumstances  the 
value  of  presenting  a  lot  of  hard-and-fast  calcu- 
lations worked  out  under  any  given  set  of  condi- 
tions is  extremely  doubtful. 

As  to  the  profit  on  business  of  this  land  it  can 
be  said  that  the  average,  where  the  best  bills  are 
used,  runs  not  much  over  twenty  points  (one- 
fifth  of  a  cent  per  pound  sterling).  From  that, 
of  course,  profits  actually  made  run  up  as  high 
as  one  cent  or  even  two  cents  per  pound,  accord- 
ing to  the  amount  of  risk  involved.  The  buying 
of  cheap  bills  is,  however,  a  most  precarious  oper- 
ation. One  single  mistake,  and  the  whole  profit 
of  months  may  be  completely  wiped  out.  The 
proposition  is  a  good  deal  like  lending  money  on 
insecure  collateral,  or  like  lending  to  doubtful 
firms.  There  are  banking  houses  which  do  it,  have 
been  doing  it  for  years,  and  by  reason  of  an  in- 
tuitive feeling  when  there  is  trouble  ahead  have 
been  able  to  avoid  heavy  losses.  Such  business, 
however,  can  hardly  be  called  high-class  banking 
practice. 


FOREIGN    EXCHANGE  83 

4.     The  Operation  of  Making  Foreign  Loans 

In  its  influence  upon  the  other  markets,  there 
is  perhaps  no  more  important  phase  of  foreign 
exchange  than  the  making  of  foreign  loans  in  the 
American  market.  How  great  is  the  amount  of 
foreign  capital  continually  loaned  out  in  this 
country  has  been  several  times  suggested  in  pre- 
vious pages.  The  mechanics  of  these  foreign 
loaning  operations,  the  way  in  which  the  money  is 
transferred  to  this  side,  etc.,  will  now  be  taken  up. 

To  begin  at  the  very  beginning,  consider  how 
favorable  a  field  is  the  American  market  for  the 
employment  of  Europe's  spare  banking  capital. 
Almost  invariably  loaning  rates  in  New  York  are 
higher  than  they  are  in  London  or  Paris.  This  is 
due,  perhaps,  to  the  fact  that  industry  here  runs 
on  at  a  much  faster  pace  than  in  England  or 
France,  or  it  may  be  due  to  the  fact  that  we  are  a 
newer  country,  that  there  is  no  such  accumulated 
fund  of  capital  here  as  there  is  abroad.  Such  a 
hypothesis  for  our  own  higher  interest  rates 
would  seem  to  be  supported  by  the  fact  that  in 
Germany,  too,  interest  is  consistently  on  a  higher 
level  than  in  London  or  Paris,  Germany,  like  our- 
selves, being  a  vigorous  industrial  nation  without 
any  very  great  accumulated  fund  of  capital  saved 


84  FOREIGN    EXCHANGE 

by  the  people.  But  whatever  the  reason,  the  fact 
remains  that  in  New  York  money  rates  are  gen- 
erally on  so  much  more  attractive  a  basis  than 
they  are  abroad  that  there  is  practically  never  a 
time  when  there  are  not  hundreds  of  millions  of 
dollars  of  English  and  French  money  loaned  out 
in  this  market. 

To  go  back  no  further  than  the  present  decade, 
it  will  be  recalled  how  great  a  part  foreign  float- 
ing capital  played  in  financing  the  ill-starred 
speculation  here  which  culminated  in  the  panic  of 
May  9,  1901.  Europe  in  the  end  of  1900  had 
gone  mad  over  our  industrial  combinations  and 
had  shovelled  her  millions  into  this  market  for 
the  use  of  our  promoters.  What  use  was  made  of 
the  money  is  well  known.  The  instance  is  men- 
tioned here,  with  others  which  follow,  only  to 
show  that  all  through  the  past  ten  years  London 
has  at  various  times  opened  her  reservoirs  of  cap- 
ital and  literallv  poured  money  into  the  American 
market. 

Even  the  experience  of  1901  did  not  daunt  the 
foreign  lenders,  and  in  1902  fresh  amounts  of  for- 
eign capital,  this  time  mostly  German,  were  se- 
cured by  our  speculators  to  push  along  the 
famous  "Gates  boom."  That  time,  however,  the 
lenders'  experience  seemed  to  discourage  them, 


FOREIGN    EXCHANGE  85 

and  until  1906  there  was  not  a  great  deal  of  for- 
eign money,  relatively  speaking,  loaned  out  here. 
In  the  summer  of  that  year,  chiefly  through  Mr. 
Harriman's  efforts,  English  and  French  capital 
began  to  come  largely  into  the  New  York  market 
— made  possible,  indeed,  the  "Harriman  Market 
of  1906."  This  was  the  money  the  terror-stricken 
withdrawal  of  which  during  most  of  1907  made 
the  panic  as  bad  as  it  was.  After  the  panic,  most 
of  what  was  left  was  withdrawn  by  foreign  lend- 
ers, so  that  in  the  middle  of  1908  the  market  here" 
was  as  bare  of  foreign  money  as  it  has  been  in 
years.  Returning  American  prosperity,  however, 
combined  with  complete  stagnation  abroad,  set 
up  another  hitherward  movement  of  foreign  cap- 
ital which,  during  the  spring  and  summer  of  1909, 
attained  amazing  proportions.  By  the  end  of  the 
summer,  indeed,  more  foreign  capital  was  em- 
ployed in  the  American  market  than  ever  before 
in  the  country's  financial  history. 

To  take  up  the  actual  operation  of  loaning  for- 
eign money  in  the  American  market,  suppose  con- 
ditions to  be  such  that  an  English  bank's  man- 
agers have  made  up  their  minds  to  loan  out  £100,- 
000  in  New  York — not  on  joint  account  with  the 
American  correspondent,  as  is  often  done,  but  en- 
tirely independently.     Included  in  the  arrange- 


86  FOREIGN    EXCHANGE 

ments  for  the  transaction  will  be  a  stipulation  as 
to  whether  the  foreign  bank  loaning  the  money 
wants  to  loan  it  on  the  basis  of  receiving  a  com- 
mission and  letting  the  borrower  take  the  risk  of 
how  demand  exchange  may  fluctuate  during  the 
life  of  the  loan,  or  whether  the  lender  prefers  to 
lend  at  a  fixed  rate  of  interest,  say  six  per  cent., 
and  himself  accept  the  risk  of  exchange. 

What  the  foregoing  means  will  perhaps  become 
more  clear  if  it  is  realized  that  in  the  first  case  the 
American  agent  of  the  foreign  lender  draws  a 
ninety  days'  sight  sterling  bill  for,  say,  £100,000 
on  the  lender,  and  hands  the  actual  bill  over  to  the 
parties  here  who  want  the  rnone)^.  Upon  the  lat- 
ter falls  the  task  of  selling  the  bill,  and,  ninety 
days  later,  when  the  time  of  repayment  comes, 
the  duty  of  returning  a  demand  bill  for  £100,000, 
plus  the  stipulated  commission.  In  the  second 
kind  of  a  loan  the  borrower  has  nothing  to  do  with 
the  exchange  part  of  the  transaction,  the  Ameri- 
can banking  agent  of  the  foreign  lender  turning 
over  to  the  borrower  not  a  sterling  draft  but  the 
dollar  proceeds  of  a  sterling  draft.  How  the  ex- 
change market  fluctuates  in  the  meantime — what 
rate  may  have  to  be  paid  at  the  end  of  ninety  days 
for  the  necessary  demand  draft — concerns  the 
borrower  not  at  all.     He  received  dollars  in  the 


FOREIGN    EXCHANGE  87 

first  place,  and  when  the  loan  comes  due  he  pays 
back  dollars,  plus  four,  five  or  six  per  cent.,  as  the 
case  may  be.  What  rate  has  to  be  paid  for  the 
demand  exchange  affects  the  banker  only,  not  the 
borrower. 

Loans  made  under  the  first  conditions  are 
known  as  sterling,  mark,  or  franc  loans;  the  other 
kind  are  usually  called  "currency  loans."  At  the 
risk  of  repetition,  it  is  to  be  said  that  in  the  case 
of  sterling  loans  the  borrower  pays  a  flat  commis- 
sion and  takes  the  risk  of  what  rate  he  may  have 
to  pay  for  demand  exchange  when  the  loan  comes 
due.  In  the  case  of  a  currency  loan  the  borrower 
knows  nothing  about  the  foreign  exchange  trans- 
action. He  receives  dollars,  and  pays  them  back 
with  a  fixed  rate  of  interest,  leaving  the  whole 
question  and  risk  of  exchange  to  the  lending 
banker. 

To  illustrate  the  mechanism  of  one  of  these 
sterling  loans.  Suppose  the  London  Bank,  Ltd., 
to  have  arranged  with  the  New  York  Bank  to 
have  the  latter  loan  out  £100,000  in  the  New 
York  market.  The  New  York  Bank  draws 
£100,000  of  ninety  days'  sight  bills,  and,  satisfac- 
tory collateral  having  been  deposited,  turns  them 
over  to  the  brokerage  house  of  Smith  k  Jones. 
Smith  &  Jones  at  once  sell  the  £100,000,  receiving 
therefor,  sav,  $484,000. 


88  FOREIGN    EXCHANGE 

The  bills  sold  by  Smith  &  Jones  find  their  way 
to  London  by  the  first  steamer,  are  accepted  and 
discounted.  Ninety  days  later  they  will  come  due 
and  have  to  be  paid,  and  ten  days  prior  to  their 
maturity  the  New  York  Bank  will  be  expecting 
Smith  &  Jones  to  send  in  a  demand  draft  for 
£100,000,  plus  three-eighths  per  cent,  commis- 
sion, making  £375  additional.  This  £100,375, 
less  its  commission  for  having  handled  the  loan, 
the  New  York  Bank  will  send  to  London,  where 
it  will  arrive  a  couple  of  days  before  the  £100,000 
of  ninety  days'  sight  bills  originally  drawn  on* 
the  London  Bank,  Ltd.,  mature. 

What  each  of  the  bankers  concerned  makes  out 
of  the  transaction  is  plain  enough.  As  to  what 
Smith  &  Jones'  ninety-day  loan  cost  them,  in  ad- 
dition to  the  flat  three-eighths  per  cent,  they  had 
to  pay,  that  depends  upon  what  they  realize  from 
the  sale  of  the  ninety  days'  sight  bills  in  the  first 
place  and  secondly  on  what  rate  they  had  to  pay 
for  the  demand  bill  for  £100,000.  Exchange  may 
have  gone  up  during  the  life  of  the  loan,  making 
the  loan  expensive,  or  it  may  have  gone  down, 
making  the  cost  very  little.  Plainly  stated,  un- 
less they  secured  themselves  by  buying  a  "future" 
for  the  delivery  of  a  £100,000  demand  bill  in 
ninety  days  at  a  fixed  rate,  Messrs.   Smith  & 


FOREIGN    EXCHANGE  89 

Jones  have  been  making  a  mild  speculation  in 
foreign  exchange. 

If  the  same  loan  had  been  made  on  the  other 
basis,  the  New  York  Bank  would  have  turned 
over  to  Smith  &  Jones  not  a  sterling  bill  for 
£100,000,  but  the  dollar  proceeds  of  such  a  bill, 
say  a  check  for  $484,000.  At  the  end  of  ninety 
days  Smith  &  Jones  would  have  had  to  pay  back 
$484,000,  plus  ninety  days'  interest  at  six  per 
cent,  $7,260,  all  of  which  cash,  less  commission, 
the  New  York  Bank  would  have  invested  in  a 
demand  bill  of  exchange  and  sent  over  to  the 
London  Bank,  Ltd.  Whatever  more  than  the 
£100,000  needed  to  pay  off  the  maturing  nineties 
such  a  demand  draft  amounted  to,  would  be  the 
London  Bank,  Ltd.'s,  profit. 

From  all  of  which  it  is  plainly  to  be  seen  that 
when  the  London  bankers  are  willing  to  lend 
money  here  and  figure  that  the  exchange  market 
is  on  the  down  track,  they  will  insist  upon  doing 
their  lending  on  the  "currency  loan"  basis — tak- 
ing the  risk  of  exchange  themselves.  Conversely, 
when  loaning  operations  seem  profitable  but  rates 
seem  to  be  on  the  upturn,  lenders  will  do  their 
best  to  put  their  money  out  in  the  form  of  "ster- 
ling loans."  Bankers  are  not  always  right  in 
their  views,  by  any  means,  but  as  a  general  prin- 


90  FOREIGN    EXCHANGE 

ciple  it  can  be  said  that  when  big  amounts  of  for- 
eign money  offered  in  this  market  are  all  offered 
on  the  "sterling  loan"  basis,  a  rising  exchange 
market  is  to  be  expected. 

As  to  the  collateral  on  these  foreign  loans,  it  is 
evident  that  there  is  as  much  chance  for  different 
ways  of  looking  at  different  stocks  as  there  is  in 
regular  domestic  loaning  operations.  Not  only 
does  the  standing  of  the  borrower  here  make  a 
difference,  but  there  are  certain  securities  which 
certain  banks  abroad  favor,  and  others,  perhaps 
just  as  good,  with  which  they  will  have  nothing 
to  do. 

Excepting  the  case  of  special  negotiation,  how- 
ever, it  may  be  said  that  the  collateral  put  up 
the  case  of  foreign  loans  in  this  market  is  of  a 
very  high  order.  Three  years  ago  this  could  hard- 
ly have  been  said,  but  one  of  the  many  beneficial 
effects  of  the  panic  was  to  greatly  raise  the  stand- 
ard of  the  collateral  required  by  foreign  lenders 
in  this  market.  It  used  formerly  to  be  more  a 
case  of  the  standing  of  the  borrower.  Nowadays 
the  collateral  is  usually  deposited  here  in  care  of  a 
banker  or  trust  company. 

From  what  has  been  said  about  the  mechanism 
of  making  these  foreign  loans,  it  is  evident  that 
no  transfer  of  cash  actually  takes  place,  and  that 


FOREIGN    EXCHANGE  91 

what  really  happens  is  that  the  foreign  banking 
institution  lends  out  its  credit  instead  of  its  cash. 
For  in  no  case  is  the  lender  required  to  put  up  any 
money.  The  drafts  drawn  upon  him  are  at 
ninety  days'  sight,  and  all  he  has  to  do  is  to  write 
the  word  "accepted,"  with  his  signature,  across 
their  face.  Later  they  wdll  be  presented  for  ac- 
tual payment,  but  by  that  time  the  "cover"  will 
have  reached  London  from  the  banker  in  America 
w7ho  drew  the  "nineties,"  and  the  maturing  bills 
will  be  paid  out  of  that.  The  foreign  lender,  in 
other  words,  is  at  no  stage  out  of  any  actual  cap- 
ital, although  it  is  true,  of  course,  that  he  has  ob- 
ligated himself  to  pay  the  drafts  on  maturity,  by 
"accepting"  them. 

Where,  then,  is  the  limit  of  what  the  foreign 
bankers  can  lend  in  the  New  York  market?  On 
one  consideration  only  does  that  depend — the 
amount  of  accepted  long  bills  which  the  London 
discount  market  will  stand.  For  all  the  ninety 
days'  sight  bills  drawn  in  the  course  of  these 
transfers  of  credit  must  eventually  be  discounted 
in  the  London  discount  market,  and  when  the 
London  discount  market  refuses  to  absorb  bills 
of  this  kind  a  material  check  is  naturally  admin- 
istered to  their  creation. 

Too  great  drawings  of  loan-bills,  as  the  long 


92  FOREIGN    EXCHANGE 

bills  drawn  to  make  foreign  loans  are  called,  are 
quickly  reflected  in  a  squeamish  London  discount 
market.  It  needs  only  the  refusal  of  the  Bank 
of  England  to  re-discount  the  paper  of  a  few 
London  banks  suspected  of  having  "accepted" 
too  great  a  quantity  of  American  loan-bills,  to 
make  it  impossible  to  go  on  loaning  profitably  in 
the  New  York  market.  In  order  to  make  loans, 
long  bills  have  to  be  drawn  and  sold  to  somebody, 
and  if  the  discount  market  in  London  will  take 
no  more  American  paper,  buyers  for  freshly-cre- 
ated American  paper  will  be  hard  to  find. 

To  get  back  to  the  part  foreign  loaning  opera- 
tions play  in  the  foreign  exchange  market  here,  it 
is  plain  that  as  no  actual  money  is  put  up,  the 
business  is  attractive  and  profitable  to  the  bank 
having  the  requisite  facilities  and  the  right  for- 
eign connection.  It  means  the  putting  of  the 
bank's  name  on  a  good  deal  of  paper,  it  is  true, 
but  only  on  the  deposit  of  entirely  satisfactory 
collateral  and  only  in  connection  with  the  assum- 
ing of  the  same  obligation  by  a  foreign  institution 
of  high  standing.  There  are  few  instances  where 
loss  in  transacting  this  form  of  business  has  been 
sustained,  while  the  profits  derived  from  it  are 
very  large. 

As  to  what   the  foreign   department  of  an 


FOREIGN    EXCHANGE  93 

American  bank  makes  out  of  the  business,  it  may 
be  said  that  that  depends  very  largely  upon 
whether  the  bank  here  acts  merely  as  a  lending 
agent  or  whether  the  operation  is  for  "joint  ac- 
count," both  as  to  risk  and  commission.  In  the 
former  case  (and  more  and  more  this  seems  to  be 
becoming  the  basis  on  which  the  business  is  done) 
both  the  American  and  the  European  bank  stands 
to  make  a  very  fair  return — always  considering 
that  neither  is  called  upon  to  put  up  one  real  dol- 
lar or  pound  sterling.  Take,  for  instance,  the 
average  sterling  loan  made  on  the  basis  of  the 
borrower  taking  all  the  risk  of  exchange  and  pay- 
ing a  flat  commission  of  three-eighths  of  one  per 
cent,  for  each  ninety  days.  That  means  that 
each  bank  makes  three-sixteenths  of  one  per  cent, 
for  every  ninety  days  the  loan  runs — the  Ameri- 
can bank  for  simply  drawing  its  ninety-day  bills 
of  exchange  and  the  English  bank  for  merely 
accepting  them.  Naturally,  competition  is  keen, 
American  banking  houses  vying  with  each  ether 
both  for  the  privilege  of  acting  as  agents  of  the 
foreign  banks  having  money  to  lend,  and  of  going 
into  joint-account  loaning  operations  with  them. 
Three-sixteenths  or  perhaps  one-quarter  of  one 
per  cent,  for  ninety  days  (three-quarters  of  one 
per  cent,  and  one  per  cent,  annually)   may  not 


94  FOREIGN    EXCHANGE 

seem  much  of  an  inducement,  but  considering  the 
fact  that  no  real  cash  is  involved,  this  percentage 
is  enough  to  make  the  biggest  and  best  banking 
houses  in  the  country  go  eagerly  after  the 
business. 

5.     The  Drawing  of  Finance-Bills 

Approaching  the  subject  of  finance-bills,  the 
author  is  well  aware  that  concerning  this  phase  of 
the  foreign  exchange  business  there  is  wide  differ- 
ence of  opinion.  Finance  bills  make  money,  but 
they  make  trouble,  too.  Their  existence  is  one  of 
the  chief  points  of  contact  between  the  foreign 
exchange  and  the  other  markets,  and  one  of  the 
principal  reasons  why  a  knowledge  of  foreign  ex- 
change is  necessary  to  any  well-rounded  under- 
standing of  banking  conditions. 

Strictly  speaking,  a  finance-bill  is  a  long  draft 
drawn  by  a  banker  of  one  country  on  a  banker 
in  another,  sometimes  secured  by  collateral,  but 
more  often  not,  and  issued  by  the  drawing  banker 
for  the  purpose  of  raising  money.  Such  bills  are 
not  always  distinguishable  from  the  bills  a  banker 
in  New  York  may  draw  on  a  banker  in  London  in 
the  operation  of  lending  money  for  him,  but  in 
nature  they  are  essentially  different.    The  draw- 


FOREIGN    EXCHANGE  95 

ing  of  finance-bills  was  recently  described  by  the 
foreign  exchange  manager  of  one  of  the  biggest 
houses  in  New  York,  during  the  course  of  a  pub- 
lic address,  as  a  "scheme  to  raise  the  wind." 
Whether  or  not  any  collateral  is  put  up,  the  whole 
purpose  of  the  drawing  of  finance-bills  is  to  pro- 
vide an  easy  way  of  raising  money  without  the 
banker  here  having  to  go  to  some  other  bank  to 
do  it. 

The  origin  of  the  ordinary  finance-bill  is  about 
as  follows:  A  bank  here  in  New  York  carries  a 
good  balance  in  London  and  works  a  substantial 
foreign  exchange  business  in  connection  with  the 
London  bank  where  this  balance  is  carried.  A 
time  comes  when  the  New  York  banking  house 
could  advantageously  use  more  money.  Arrange- 
rients  are  therefore  made  with  the  London  bank 
whereby  the  London  bank  agrees  to  "accept"  a 
certain  amount  of  the  American  banker's  long 
bills,  for  a  commission.  In  the  course  of  his  regu- 
lar business,  then,  the  American  banker  simply 
draws  that  many  more  pounds  sterling  in  long 
bills,  sells  them,  and  for  the  time  being  has  the 
use  of  the  money.  In  the  great  maj  ority  of  cases 
no  extra  collateral  is  put  up,  nor  is  the  London 
bank  especially  secured  in  any  way.  The  Ameri- 
can banker's  credit  is  good  enough  to  make  the 


96  FOREIGN    EXCHANGE 

English  banker  willing,  for  a  commission,  to  "ac- 
cept" his  drafts  and  obligate  himself  that  the 
drafts  will  be  paid  at  maturity.  Naturally,  a 
house  has  to  be  in  good  standing  and  enjoy  high 
credit  not  only  here  but  on  the  other  side  before 
any  reputable  London  bank  can  be  induced  to 
"accept"  its  finance  paper. 

The  ability  to  draw  finance-bills  of  this  kind 
often  puts  a  house  disposed  to  take  chances  with 
the  movement  of  the  exchange  market  into  line 
for  very  considerable  profit  possibilities.  Sup- 
pose, for  instance,  that  the  manager  of  a  house 
here  figures  that  there  is  going  to  be  a  sharp 
break  in  foreign  exchange.  He,  therefore,  sells 
a  line  of  ninety-day  bills,  putting  himself  tech- 
nically short  of  the  exchange  market  and  banking 
on  the  chance  of  being  able  to  buy  in  his  "cover" 
cheaply  when  it  comes  time  for  him  to  cover.  In 
the  meantime  he  has  the  use  of  the  money  he  de- 
rived from  the  sale  of  the  "nineties"  to  do  with  as 
he  pleases,  and  if  he  has  figured  the  market  aright, 
it  may  not  cost  him  any  more  per  pound  to  buy 
his  "cover"  than  he  realized  from  the  sale  of  the 
long  bills.  In  which  case  he  would  have  had  the 
use  of  the  money  for  the  whole  three  months  prac- 
tically free  of  interest. 

It  is  plain  speculating  in  exchange — there  is  no 


FOREIGN    EXCHANGE  97 

getting  away  from  it,  and  yet  this  practice  of  sell- 
ing finance-bills  gives  such  an  opportunity  to  the 
exchange  manager  shrewd  enough  to  read  the 
situation  aright  to  make  money,  that  many  of  the 
big  houses  go  in  for  it  to  a  large  extent.  During 
the  summer,  for  instance,  if  the  outlook  is  for  big 
crops,  the  situation  is  apt  to  commend  itself  to 
this  kind  of  operation.  Money  in  the  summer 
months  is  apt  to  be  low  and  exchange  high,  af- 
fording a  good  basis  on  which  to  sell  exchange. 
Then,  if  the  expected  crops  materialize,  large 
amounts  of  exchange  drawn  against  exports  will 
come  into  the  market,  forcing  down  rates  and  giv- 
ing the  operator  who  has  previously  sold  his  long 
bills  an  excellent  chance  to  cover  them  profitably 
as  they  come  due. 

About  the  best  example  of  how  exchange  man- 
agers can  be  deceived  in  their  forecasts  is  afforded 
by  the  movement  of  exchange  during  the  summer 
and  fall  of  1909.  Impelled  thereto  by  the  brilliant 
crop  prospects  of  early  summer,  foreign  exchange 
houses  in  New  York  drew  and  sold  finance- 
bills  in  enormous  volume.  The  corn  crop  was  to 
run  over  three  billion  bushels,  affording  an  unpre- 
cedented exportable  surplus — wheat  and  cotton 
were  both  to  show  record-breaking  yields.  But 
instead  of  these  promises  being  fulfilled,  wheat 


98  FOREIGN    EXCHANGE 

and  corn  showed  only  average  yields,  while  the 
cotton  crop  turned  out  decidedly  short.  The  ex- 
pected flood  of  exchange  never  materialized.  On 
the  contrary,  rise  in  money  rates  abroad  caused 
such  a  paying  off  of  foreign  loans  and  maturing 
finance  bills  that  foreign  exchange  rose  to  the 
gold  export  point  and  "covering"  operations  were 
conducted  with  extreme  difficulty.  In  the  foreign 
exchange  market  the  autumn  of  1909  will  long  be 
remembered  as  a  time  when  the  finance-bill  sellers 
had  administered  to  them  a  lesson  which  they  will 
be  a  good  while  in  forgetting. 

6.     Arbitraging  in  Exchange 

Arbitraging  in  exchange — the  buying  by  a  New 
York  banker,  for  instance,  through  the  medium 
of  the  London  market,  of  exchange  drawn  on 
Paris,  is  another  broad  and  profitable  field  for  the 
operations  of  the  expert  foreign  exchange  man- 
ager. Take,  for  example,  a  time  when  exchange 
on  Paris  is  more  plentiful  in  London  than  in  New 
York — a  shrewd  New  York  exchange  manager 
needing  a  draft  on  Paris  might  well  secure  it  in 
London  rather  than  in  his  home  city.  The  follow- 
ing operation  is  only  one  of  ten  thousand  in  which 
exchange  men  are  continually  engaged,  but  is  a 
representative  transaction  and  one  on  which  a 


FOREIGN    EXCHANGE  99 

good  deal  of  the  business  in  the  arbitration  of  ex- 
change is  based. 

Suppose,  for  instance,  that  in  New  York,  de- 
mand exchange  on  Paris  is  quoted  at  five  francs 
seventeen  and  one-half  centimes  per  dollar,  de- 
mand exchange  on  London  at  $4.84  per  pound, 
and  that,  in  London,  exchange  on  Paris  is  ob- 
tainable at  twenty-five  francs  twenty-five  cen- 
times per  pound.  The  following  operation  would 
be  possible : 

Sale  by  a  New  York  banker  of  a  draft  on 
Paris,  say,  for  francs  25,250,  at  5.171/2,  bringing 
him  in  $4,879.23.  Purchase  by  same  banker 
of  a  draft  on  London  for  £1,000,  at  4.84,  costing 
him  $4,840.  Instructions  by  the  American  bank- 
er to  his  London  correspondent  to  buy  a  check 
on  Paris  for  francs  25,250  in  London,  and  to  send 
it  over  to  Paris  for  the  credit  of  his  (the  Ameri- 
can banker's  account).  Such  a  draft,  at  25.25 
would  cost  just  £1,000. 

The  circle  would  then  be  complete.  The  Amer- 
ican banker  who  originally  drew  the  francs  25,250 
on  his  Paris  balance  would  have  replaced  that 
amount  in  his  Paris  balance  through  the  aid  of  his 
London  correspondent.  The  London  correspond- 
ent would  have  paid  out  £1,000  from  the  Ameri- 
can banker's  balance  with  him,  a  draft  for  which 


100  FOREIGN    EXCHANGE 

amount  would  come  in  the  next  mail.  All  parties 
to  the  transaction  would  be  satisfied — especially 
the  banker  who  started  it,  for  whereas  he  paid 
out  $4,840  for  the  £1,000  draft  on  London,  he 
originally  took  in  $4,879.23  for  the  draft  he  sold 
on  Paris. 

Between  such  cities  as  have  been  used  in  the 
foregoing  illustrations  rates  are  not  apt  to  be 
wide  enough  apart  to  afford  any  such  actual 
profit,  but  the  chance  for  arbitr aging  does  exist 
and  is  being  continuously  taken  advantage  of. 
So  keenly,  indeed,  are  the  various  rates  in  their 
possible  relation  to  one  another  watched  by  the 
exchange  men  that  it  is  next  to  impossible  for 
them  to  "open  up"  to  any  appreciable  extent.  The 
chance  to  make  even  a  slight  profit  by  shifting 
balances  is  so  quickly  availed  of  that  in  the  con- 
stant demand  for  exchange  wherever  any  relative 
weakness  is  shown,  there  exists  a  force  which 
keeps  the  whole  structure  at  parity.  The  ability  to 
buy  drafts  on  Paris  relatively  much  cheaper  at 
London  than  at  New  York,  for  instance,  would 
be  so  quickly  taken  advantage  of  by  half  a  dozen 
watchful  exchange  men  that  the  London  rate  on 
Paris  would  quickly  enough  be  driven  up  to  its 
right  relative  position. 

It  is  impossible  in  this  brief  treatise  to  give 


FOREIGN   EXCHANGE  101 

more  than  a  suggestion  of  the  various  kinds  of  ex- 
change arbitration  being  carried  on  all  the  time. 
Experts  do  not  confine  their  operations  to  the 
main  centers,  nor  is  three  necessarily  the  largest 
number  of  points  which  figure  in  transactions  of 
this  sort.  Elaborate  cable  codes  and  a  constant 
use  of  the  wires  keep  the  up-to-date  exchange 
manager  in  touch  with  the  movement  of  rates  in 
every  part  of  Europe.  If  a  chance  exists  to  sell 
a  draft  on  London  and  then  to  put  the  requisite 
balance  there  through  an  arbitration  involving 
Paris,  Brussels,  and  Amsterdam,  the  chances  are 
that  there  will  be  some  shrewd  manager  who  will 
find  it  out  and  put  through  the  transaction.  Some 
of  the  larger  banking  houses  employ  men  who  do 
little  but  look  for  just  such  opportunities.  When 
times  are  normal,  the  margin  of  profit  is  small, 
but  in  disturbed  markets  the  parities  are  not  near- 
ly so  closely  maintained  and  substantial  profits 
are  occasionally  made.  The  business,  however, 
is  of  the  most  difficult  character,  requiring  not 
only  great  shrewdness  and  judgment  but  ex- 
ceptional mechanical  facilities. 

7.    Dealing  in  "Futures  " 

As  a  means  of  making — or  of  losing — money, 
in  the  foreign  exchange  business,  the  dealing  in 


102  FOREIGN    EXCHANGE 

contracts  for  the  future  delivery  of  exchange  has, 
perhaps,  no  equal.  And  yet  trading  in  futures  is 
by  no  means  necessarily  speculation.  There  are 
at  least  two  broad  classes  of  legitimate  operation 
in  which  the  buying  and  selling  of  contracts  of 
exchange  for  future  delivery  plays  a  vital  part. 

Take  the  case  of  a  banker  who  has  bought  and 
remitted  to  his  foreign  correspondent  a  miscel- 
laneous lot  of  foreign  exchange  made  up  to  the 
extent  of  one-half,  perhaps,  of  commercial  long 
bills  with  documents  deliverable  only  on  "pay- 
ment" of  the  draft.  That  means  that  if  the  whole 
batch  of  exchange  amounted  to  £50,000,  .£25,000 
of  it  might  not  become  an  available  balance  on  the 
other  side  for  a  good  while  after  it  had  arrived 
there — not  until  the  parties  on  whom  the  "pay- 
ment" bills  were  drawn  chose  to  pay  them  off  un- 
der rebate.  The  exchange  rate,  in  the  meantime, 
might  do  almost  anything,  and  the  remitting 
banker  might  at  the  end  of  thirty  or  forty-five 
days  find  himself  with  a  balance  abroad  on  which 
he  could  sell  his  checks  only  at  very  low  rates. 

To  protect  himself  in  such  case  the  banker 
would,  at  the  time  he  sent  over  the  commercial 
exchange,  sell  his  own  demand  drafts  for  future 
delivery.  Suppose  that  he  had  sent  over  £25,000 
of  commercial  "payment"  bills.     Unable  to  tell 


FOREIGN    EXCHANGE  103 

exactly  when  the  proceeds  would  become  avail- 
able, the  banker  buying  the  bills  would  neverthe- 
less presumably  have  had  experience  with  bills  of 
the  same  name  before  and  would  be  able  to  form 
a  pretty  accurate  estimate  as  to  when  the  drawees 
would  be  likely  to  "take  them  up"  under  rebate. 
It  would  be  reasonably  safe,  for  instance,  for  the 
banker  to  sell  futures  as  follows :  ,£5,000  deliver- 
able in  fifteen  days;  £10,000  deliverable  in  thirty 
days,  £10,000  deliverable  in  from  forty-five  to 
sixty  days.  Such  drafts  on  being  presented  could 
in  all  probability  be  taken  care  of  out  of  the  pre- 
payments on  the  commercial  bills. 

By  figuring  with  judgment,  foreign  exchange 
bankers  are  often  able  to  make  substantial  profits 
on  operations  of  this  kind.  An  exchange  broker 
comes  in  and  offers  a  banker  here  a  lot  of  good 
"payment"  commercial  bills.  The  banker  finds 
that  he  can  sell  his  own  draft  for  delivery  at 
about  the  time  the  commercial  drafts  are  apt  to  be 
paid  under  rebate,  at  a  price  which  means  a  good 
net  profit.  The  operation  ties  up  capital,  it  is 
true,  but  is  without  risk.  Not  infrequently  good 
commercial  "payment"  bills  can  be  bought  at 
such  a  price  and  bankers'  futures  sold  against 
them  at  such  a  price  that  there  is  a  substantial 
profit  to  be  made. 


104  FOREIGN    EXCHANGE 

The  other  operation  is  the  sale  of  bankers' 
futures,  not  against  remittances  of  actual  com- 
mercial exchange  but  against  exporters'  futures. 
Exporters  of  merchandise  frequently  quote  prices 
to  customers  abroad  for  shipment  to  be  made  in 
some  following  month,  to  establish  which  fixed 
price  the  exporter  has  to  fix  a  rate  of  exchange 
definitely  with  some  banker.  "I  am  going  to  ship 
so-and-so  so  many  tubs  of  lard  next  May,"  says 
the  exporter  to  the  banker,  "the  drafts  against 
them  will  amount  to  so-and-so-much.  What  rate 
will  you  pay  me  for  them — delivery  next  May?" 
The  banker  knows  he  can  sell  his  own  draft  for 
May  delivery  for,  say,  4.87.  He  bids  the  ex- 
porter 4.86%  for  his  lard  bills,  and  gets  the  con- 
tract. Without  any  risk  and  without  tying  up  a 
dollar  of  capital  the  banker  has  made  one-half 
cent  per  pound  sterling  on  the  whole  amount  of 
the  shipment.  In  May,  the  lard  bills  will  come 
in  to  him,  and  he  will  pay  for  them  at  a  rate  of 
4.86%,  turning  around  and  delivering  his  own 
draft  against  them  at  4.87. 

Selling  futures  against  futures  is  not  the  easiest 
form  of  foreign  exchange  business  to  put  through, 
but  when  a  house  has  a  large  number  of  commer- 
cial exporters  among  its  clients  there  are  gen- 
erally to  be  found  among  them  some  who  want  to 


FOREIGN    EXCHANGE  105 

sell  their  exchange  for  future  delivery.  As  to 
the  buyer  of  the  banker's  "future,"  such  a  buyer 
might  be,  for  instance,  another  banker  who  had 
sold  finance-bills  and  wants  to  limit  the  cost  of 
"covering"  them. 

The  foregoing  examples  of  dealing  in  futures 
are  merely  examples  of  how  futures  may  figure 
in  every-day  exchange  transactions.  Like  opera- 
tions in  exchange  arbitrage,  there  is  no  limit  to 
the  number  of  kinds  of  business  in  which  "fu- 
tures" may  figure.  They  are  a  much  abused  in- 
stitution, but  are  a  vital  factor  in  modern  methods 
of  transacting  foreign  exchange  business. 

The  foregoing  are  the  main  forms  of  activity  of 
the  average  foreign  department,  though  there  are, 
of  course,  many  other  ways  of  making  money  out 
of  foreign  exchange.  The  business  of  granting 
commercial  credits,  the  exporting  and  importing 
of  gold  and  the  business  of  international  trading 
in  securities  will  be  taken  up  separately  in  follow- 
ing chapters. 


CHAPTER    VII 

GOLD  EXPORTS  AND  IMPORTS 

GOLD  exports  and  imports,  while  not  con- 
stituting any  great  part  of  the  activity 
of  the  average  foreign  department,  are 
nevertheless  a  factor  of  vital  importance  in  deter- 
mining the  movement  of  exchange.  The  loss  of 
gold,  in  quantity,  by  some  market  may  bring 
about  money  conditions  resulting  in  very  violent 
movements  of  exchange;  or,  on  the  other  hand, 
such  movements  may  be  caused  by  the  efforts  of 
the  controlling  financial  interests  in  some  market 
to  attract  gold.  The  movement  of  exchange  and 
the  movement  of  gold  are  absolutely  dependent 
one  on  the  other. 

Considering  broadly  this  question  of  the  move- 
ment of  gold,  it  is  to  be  borne  in  mind  that  by  far 
the  greater  part  of  the  world's  production  of  the 
precious  metal  takes  place  in  countries  ranking 
very  low  as  to  banking  importance.  The  United 
States,  is  indeed,  the  only  first-class  financial 
power  in  which  any  very  considerable  proportion 
of  the  world's  gold  is  produced.    Excepting  the 

106 


FOREIGN    EXCHANGE  107 

ninety  million  dollars  of  gold  produced  in  the 
United  States  in  1908,  nearly  all  of  the  total  pro- 
duction of  430  million  dollars  for  that  year  was 
taken  out  of  the  ground  in  places  where  there  ex- 
ists but  the  slightest  demand  for  it  for  use  in 
banking  or  the  arts. 

That  being  the  case,  it  follows  that  there  is  to 
be  considered,  first,  the  primary  movement  of 
nearly  all  the  gold  produced — the  movement 
from  the  mines  to  the  great  financial  centers. 

Considering  that  over  half  the  gold  taken  out 
of  the  ground  each  year  is  mined  in  British  pos- 
sessions, it  is  only  natural  that  London  should  be 
the  greatest  distributive  point.  Such  is  the  case. 
Ownership  of  the  mines  which  produce  most  of 
the  world's  gold  is  held  in  London,  and  so  it  is  to 
the  British  capital  that  most  of  the  world's  gold 
comes  after  it  has  been  taken  out  of  the  ground. 
By  every  steamer  arriving  from  Australia  and 
South  Africa  great  quantities  of  the  metal  are 
carried  to  London,  there  to  be  disposed  of  at  the 
best  price  available. 

For  raw  gold,  like  raw  copper  or  raw  iron,  has 
a  price.  Under  the  English  banking  law,  it  is 
true,  the  Bank  of  England  must  buy  at  the  rate 
of  seventy-seven  shillings  nine  pence  per  ounce 
all  the  gold  of  standard  (.916  2-3)  fineness  which 


108  FOREIGN    EXCHANGE 

may  be  offered  it,  but  that  establishes  merely  a 
minimum — there  is  no  limit  the  other  way  to 
which  the  price  of  the  metal  may  not  be  driven 
under  sufficiently  urgent  bidding. 

The  distribution  of  the  raw  gold  is  effected  as 
follows :  Each  Monday  morning  there  is  held  an 
auction  at  which  are  present  all  the  representa- 
tives of  home  or  foreign  banks  who  may  be  in  the 
market  for  gold.  These  representatives,  fully 
apprised  of  the  amount  of  the  metal  which  has 
arrived  during  the  preceding  week  and  which  is 
to  be  sold,  know  exactly  how  much  they  can  bid. 
The  gold,  therefore,  is  sold  at  the  best  possible 
price,  and  finds  its  way  to  that  point  where  the 
greatest  urgency  of  demand  exists.  It  may  be 
Paris  or  Berlin,  or  it  may  be  the  Bank  of  Eng- 
land. According  as  the  representatives  present 
at  the  auction  may  bid,  the  disposition  of  the  gold 
is  determined. 

The  primary  disposition.  For  the  fact  that 
Berlin,  for  instance,  obtains  the  bulk  of  the  gold 
auctioned  off  on  any  given  Monday  by  no  means 
proves  that  the  gold  is  going  to  remain  for  any 
length  of  time  in  Berlin.  For  some  reason,  in 
that  particular  case,  the  representatives  of  the 
German  banks  had  been  instructed  to  bid  a  price 
for  the  gold  which  would  bring  it  to  Berlin,  but 


FOREIGN    EXCHANGE  109 

the  conditions  furnishing  the  motive  for  such  a 
move  may  remain  operative  only  a  short  time  and 
the  need  for  the  metal  pass  away  with  them. 
Quarterly  settlements  in  Berlin  or  the  flotation  of 
a  Russian  loan  in  Paris,  for  instance,  might  be 
enough  to  make  the  German  and  French  banks' 
representatives  go  in  and  bid  high  enough  to  get 
the  new  gold,  but  with  the  passing  of  the  quar- 
ter's end  or  the  successful  launching  of  the  loan 
would  pass  the  necessity  for  the  gold,  and  its  re- 
distribution would  begin. 

In  other  words,  both  the  primary  movement  of 
gold  from  the  mines  and  the  secondary  movement 
from  the  distributive  centers  are  merely  tempo- 
rary and  show  little  as  to  the  final  lodgment  of 
the  precious  metal.  What  really  counts  is  ex- 
change conditions;  it  is  along  the  lines  of  the 
favorable  exchange  that  the  great  currents  of 
gold  will  inevitably  flow. 

For  example,  if  a  draft  for  pounds  sterling 
drawn  on  London  can  be  bought  here  at  a  low 
rate  of  exchange,  anything  in  London  that  the 
American  consumer  may  want  to  possess  him- 
self of  can  be  bought  cheaper  than  when  ex- 
change on  London  is  high.  The  price  of  a  hat  in 
London  is,  say,  £l.  With  exchange  at  4.83  it 
will  cost  a  buyer  in  New  York  only  $4.83  to  buy 


110  FOREIGN    EXCHANGE 

that  hat;  if  exchange  were  at  4.88,  it  would  cost 
him  $4.88.  Similarly  with  raw  copper  or  raw 
gold  or  any  other  commodity.  Given  a  low  rate 
of  exchange  on  any  point  and  it  is  possible  for 
the  outside  markets  to  buy  cheaply  at  that  point. 

And  a  very  little  difference  in  the  price  of  ex- 
change makes  a  very  great  difference  so  far  as 
the  price  of  gold  is  concerned.  As  stated  in  a 
previous  chapter,  a  new  gold  sovereign  at  any 
United  States  assay  office  can  be  converted  into 
$4.8665,  so  that  if  it  cost  nothing  to  bring  a  new 
sovereign  over  here,  no  one  holding  a  draft  for  a 
pound  (a  sovereign  is  a  gold  pound)  would  sell 
it  for  less  than  $4.8665,  but  would  simply  order 
the  sovereign  sent  over  here  and  cash  it  in  for 
$4.8665  himself.  Always  assuming  that  it  cost 
nothing  to  bring  over  the  actual  gold,  every  time 
it  became  possible  to  buy  a  draft  for  less  than 
$4.8665,  some  buyer  would  snatch  at  the  chance. 

Such  a  case,  with  <£l  as  the  amount  of  the  draft 
and  the  assumption  of  no  charge  for  importing 
the  gold,  is,  of  course,  mentioned  merely  for  pur- 
poses of  illustration.  From  it  should,  however, 
become  clear  the  whole  idea  underlying  gold  im- 
ports. A  new  sovereign  laid  down  in  New  York 
is  worth,  at  any  time,  $4.8665.  If  it  is  possible 
to  get  the  sovereign  over  here  for  less  than  that — 


FOREIGN    EXCHANGE  111 

by  paying  $4.83  for  a  £l  draft  on  London,  for 
instance,  and  three  cents  for  charges,  $4.86  in  all 
— it  is  possible  to  bring  the  sovereign  in  and  make 
money  doing  it. 

Whether  the  gold  imported  is  in  the  form  of 
sovereigns  or  whether  it  consists  of  bars  makes 
not  the  slightest  difference  so  far  as  the  principle 
of  the  thing  is  concerned.  A  sovereign  is  at  all 
times  worth  just  so  and  so  much  at  any  United 
States  assay  office,  and  an  ounce  of  gold  of  any 
given  fineness  is  worth  just  so  and  so  much,  too, 
regardless  of  where  it  comes  from.  So  that  in 
importing  gold,  whether  the  metal  be  in  the  form 
of  coin  or  bars,  the  great  thing  is  the  cheapness 
with  which  it  can  be  secured  in  some  foreign  mar- 
ket. If  it  can  be  secured  so  cheaply  in  London, 
for  example,  that  the  price  paid  for  each  pound 
(sovereign)  of  the  draft,  plus  the  charge  of 
bringing  in  each  sovereign,  is  less  than  what  the 
sovereign  can  be  sold  for  when  it  gets  here,  it  will 
pay  to  buy  English  gold  and  bring  it  in. 

Exactly  the  same  principle  applies  where  the 
question  is  of  importing  gold  bars  instead  of 
sovereigns,  except  that  bars  cannot  be  bought  in 
London  at  a  fixed  rate.  That,  however,  in  no 
way  affects  the  underlying  principle  that  in  im- 
porting gold  the  profit  is  made  by  selling  the 


112  FOREIGN    EXCHANGE 

gold  here  for  more  dollars  than  the  combined 
dollar-cost  of  the  draft  on  London  with  which 
the  gold  is  bought  and  the  charges  incurred  in  im- 
porting the  metal.  To  illustrate,  if  the  draft 
cost  $997,000  and  the  charges  amounted  to 
$3,000,  the  gold  (whether  in  the  form  of  sov- 
ereigns, eagles  or  bars)  would  have  to  be  sold  here 
for  at  least  $1,000,000,  to  have  the  importer  come 
out  even. 

With  exports,  the  theory  of  the  thing  is  to 
sell  a  draft  on,  say,  London,  for  more  dollars 
than  the  dollar-cost  of  enough  gold,  plus  charges, 
to  meet  the  draft.  As  will  be  seen  from  the  fig- 
ures of  an  actual  shipment,  given  further  on,  the 
banker  who  ships  gold  gets  the  money  to  buy  the 
gold  from  the  Treasury  here,  by  selling  a  sterling 
draft  on  London.  Suppose,  for  example,  a  New 
York  banker  wants  to  create  a  £200,000  balance 
in  London.  Figuring  how  many  ounces  of  gold 
(at  the  buying  price  in  London)  will  give  him 
the  £200,000  credit,  he  buys  that  much  gold  and 
sends  it  over.  Suppose  the  combined  cost  of  the 
gold  and  the  charge  for  shipping  it  amounts  to 
$976,000.  If  the  banker  here  can  sell  a  £200,000 
draft  against  it  at  4.88,  he  will  just  get  back  the 
$976,000  he  laid  out  originally  and  be  even  on 
the  transaction. 


FOREIGN    EXCHANGE  113 

Before  passing  from  the  theory  to  the  practice 
of  gold  exports  and  imports,  there  is  to  be  con- 
sidered the  fact  that  bar  gold  sells  in  London  at 
a  constantly  varying  price,  while  in  New  York  it 
sells  at  a  definitely  fixed  price>  In  New  York 
an  ounce  of  gold  of  any  given  fineness  can  always 
be  sold  for  the  same  amount  of  dollars  and  cents, 
but  in  London  the  amount  of  shillings  and  pence 
into  which  it  is  convertible  varies  constantly.  So 
that  a  New  York  banker  figuring  on  bringing  in 
bar  gold  from  London  has  to  take  carefully  into 
account  what  the  price  per  ounce  of  bar  gold  over 
there  is.  Sovereigns  are  seldom  imported  because 
they  are  secured  in  London  not  by  weight  but  by 
face  value, — even  if  the  sovereigns  have  lost 
weight  they  cost  just  as  many  pounds  sterling  to 
secure.  Where  the  New  York  banker  is  export- 
ing gold,  on  the  other  hand,  the  price  at  which 
bar  gold  is  selling  in  London  is  just  as  important 
as  where  he  is  importing.  For  the  price  at  which 
the  gold  can  be  disposed  of  when  it  gets  to  Lon- 
don determines  into  how  many  pounds  sterling  it 
can  be  converted. 

These  matters  of  the  cost  of  gold  in  one  market 
and  the  crediting  of  the  gold  in  some  other  mar- 
ket are  not  the  easiest  thing  to  grasp  at  first 
thought,  but  will  perhaps  become  quite  clear  by 


114  FOREIGN    EXCHANGE 

reference  to  the  accompanying  calculation  of 
actual  gold  export  and  gold  import  transactions. 
All  the  way  through  it  must  be  remembered  that 
the  figures  of  such  calculations  can  never  be  abso- 
lute— that  insurance  and  freight  charges  vary  and 
that  different  operations  are  conducted  along 
different  lines.  The  two  operations  described 
embody,  however,  the  principle  of  both  the  out- 
ward and  inward  movement  of  bar  gold  at  New 
York. 

Export  of  Bars  to  London 

In  the  transaction  described  below  about  a 
quarter  of  a  million  dollars'  worth  of  bar  gold  is 
shipped  to  London,  the  money  to  pay  for  the  gold 
being  raised  by  the  drawing  and  selling  of  a  de- 
mand draft  on  London.  Assuming  that  the  draft 
is  drawn  and  the  gold  shipped  at  the  same  time, 
the  draft  will  be  presented  fully  three  days  before 
the  gold  is  credited,  that  being  the  time  necessary 
for  assaying,  weighing,  etc.  In  other  words,  there 
will  be  an  "overdraft"  for  at  least  three  days,  in- 
terest on  which  will  have  to  be  figured  as  a  part 
of  the  cost  of  the  operation. 

Following  is  the  detailed  statement : 


FOREIGN    EXCHANGE  115 

13,195%  ounces  bar  gold  (-9166  fine)  purchased 
from    U.    S.    Treasury    or    Sub-Treasury    at 

$18.9459  per  ounce   $250,000 

Assay  office  charge  (4  cents  per  $100) 100 

Cartage  and  packing 20 

Freight  (5-32  per  cent.)   390 

Insurance  (1-20  per  cent) 125 

Interest  on  overdraft  in  London  (from  time  draft 
has  to  be  paid  until  the  gold  is  credited)  3 
days  at  4  per  cent 83 

Total  expense  of  buying  and  shipping  the 

gold    $250,718 

13,195%  ounces  of  gold  credited  in  London  at  77 
shillings  10%  pence £51,380 

Draft  on  London  for  £51,380,  sold  by  shipper 

of  the  gold,  at  487-96   $250,718 

In  the  transaction  described  above,  the  "over- 
draft" caused  by  the  inevitable  delay  in  assaying 
and  weighing  the  gold  on  its  arrival  in  London 
lasted  for  three  days,  the  American  banker  being 
charged  interest  at  the  rate  of  four  per  cent. 
487.96  being  the  rate  at  which  the  banker  export- 
ing the  gold  was  able  to  sell  his  demand  draft  at 
the  time,  was,  under  those  conditions,  the  "gold 
export  point." 

In  this  particular  operation,  which  was  under- 
taken purely  for  advertising  purposes,  the  ship- 


116  FOREIGN    EXCHANGE 

per  of  the  gold  came  out  exactly  even.  Suppose, 
however,  that  he  had  been  able  to  sell  his  draft, 
against  the  gold  shipped,  at  4.88  instead  of 
4.87%.  That  would  have  meant  twenty-five 
points  (one-quarter  cent  per  pound)  more, 
which,  on  £51,380,  would  have  amounted  to 
$128.25. 

This  question  of  the  profit  on  gold  exports  is 
both  interesting  and,  because  it  has  a  strong  bear- 
ing at  times  on  the  question  of  whether  or  not  to 
ship  gold,  important.  No  rule  can  be  laid  down 
as  to  what  profit  bankers  expect  to  make  on  ship- 
ments. If,  for  instance,  a  banker  owes  £200,000 
abroad  himself  and  finds  it  cheaper  to  send  gold 
than  to  buy  a  bill,  the  question  of  profit  does  not 
enter  at  all.  Then,  again,  many  and  many  an 
export  transaction  is  induced  by  ulterior  motives 
— it  may  be  for  the  sake  of  advertising,  or  for 
stock  market  purposes,  or  because  some  corre- 
spondent abroad  needs  the  gold  and  is  willing  to 
pay  for  it.  Any  one  of  these  or  many  like  reasons 
may  explain  the  phenomenon,  occasionally  seen, 
of  gold  exports  at  a  time  when  conditions  plainly 
indicate  that  the  exporter  is  shipping  at  a  loss. 

As  a  rule,  however,  when  exchange  is  scarce 
and  the  demand  so  great  that  bankers  who  do  not 
themselves  owe  money  abroad  see  a  chance  to  sup- 


FOREIGN    EXCHANGE  117 

ply  the  demand  for  exchange  by  shipping  gold 
and  drawing  drafts  against  it,  the  profit  amounts 
to  anywhere  from  $400  to  $1,000  on  each  million 
dollars  shipped — for  less  than  the  first  amount 
named  it  is  hardly  worth  while  to  go  into  the 
transaction  at  all;  on  the  other  hand,  conditions 
have  to  be  pretty  much  disordered  to  force  ex- 
change to  a  point  where  the  larger  amount  named 
can  be  earned. 

Import  of  Bars  from  London 

Turning  now  to  the  discussion  of  the  conditions 
under  which  gold  is  imported,  it  will  appear  from 
the  following  calculation  that  interest  plays  a 
much  more  important  part  in  the  case  of  gold 
imports  than  in  the  case  of  exports.  With  ex- 
ports, as  has  been  shown,  the  interest  charge  is 
merely  on  a  three  days'  overdraft,  but  in  the  case 
of  imports  the  banker  who  brings  in  the  gold 
loses  interest  on  it  for  the  whole  time  it  is  in 
transit  and  for  a  day  or  two  on  each  end,  besides. 
A  New  York  banker,  carrying  a  large  balance  in 
London,  for  instance,  orders  his  London  corre- 
spondent to  buy  and  ship  him  a  certain  amount  of 
bar  gold.  This  the  London  banker  does,  charg- 
ing the  cost  of  the  metal,  and  all  shipping  charges, 
to  the  account  of  the  New  York  banker.    On,  the 


118  FOREIGN    EXCHANGE 

whole  amount  thus  charged,  therefore,  the  New 
York  banker  loses  interest  while  the  gold  is  afloat. 
Even  after  the  gold  arrives  in  New  York,  of 
course,  the  depleted  balance  abroad  continues  to 
draw  less  interest  than  formerly,  but  to  make  up 
for  that  the  gold  begins  to  earn  interest  as  soon  as 
it  gets  here. 

The  transaction  given  below  is  one  which  was 
made  under  the  above  conditions — the  importer 
in  New  York  had  a  good  balance  in  London  and 
ordered  his  London  correspondent  to  buy  and 
ship  about  $1,000,000  of  gold,  charging  the  cost 
and  all  expenses  to  his  (the  New  York  banker's) 
account.  In  this  particular  case  the  interest  lost 
in  London  was  at  six  per  cent,  and  lasted  for  ten 
days. 

Cost  in  the  London  market  of  52,782  ounces  of 
gold   (.9166  fine)  at  77  shillings,   11%  pence 

per  ounce £205,795 

Freight  (5-32  per  cent.)   320 

Insurance    1 02 

Boxing  and  carting   9 

Commission  for  buying  the  gold 26 

Interest  on  cost  of  gold  and  on  charges,  while 

gold  is  in  transit,  10  days  at  6  per  cent S43 


£206,595 
Proceeds,  at  U.  S.  Sub-Treasury  in  New  York, 
of  the  52,782  ounces  of  gold  at  $18.9459  per 

ounce    $1 ,000.000 

$1,000,000   invested   in    a   cable   on    London    at 

$484.04    £206,595 


FOREIGN    EXCHANGE  119 

In  the  above  calculation  it  will  be  seen  that  the 
proceeds  of  the  gold  imported  were  exactly 
enough  to  buy  a  cable  on  London  sufficiently 
large  to  cancel  the  original  outlay  for  the  gold 
and  the  expenses  incurred  in  shipping  it  over  here. 
On  the  whole  transaction  the  banker  importing 
the  gold  came  out  exactly  even;  a  trifle  over 
4.84  was  the  "gold  import  point"  at  the  time. 

In  a  general  way  it  can  be  said  that  the  profit 
made  on  gold  import  operations  is  less  than  where 
gold  is  exported.  Banking  houses  big  enough 
and  strong  enough  to  engage  in  business  of  this 
character  are  more  apt  to  be  on  the  constructive 
side  of  the  market  than  on  the  other,  and  will 
frequently  bring  in  gold  at  no  profit  to  them- 
selves, or  even  at  a  loss,  in  order  to  further  their 
^>lans.  It  does  happen,  of  course,  that  gold  is 
sometimes  shipped  out  for  stock  market  effect, 
but  the  effect  of  gold  exports  is  growing  less  and 
less.  Gold  imports,  on  the  other  hand,  are  al- 
ways a  stimulating  factor  and  are  good  live  stock 
market  ammunition  as  well  as  a  constructive 
argument  regarding  the  price  of  investments  in 
general. 


120  FOREIGN    EXCHANGE 

Exports  of  Gold  Bars  to  Paris— the  "Triangular 
Op^,  ation  " 

Calculations  have  been  given  regarding  the 
movement  of  bar  gold  between  London  and  New 
York — what  is  ordinarily  known  as  the  "direct" 
movement.  "Indirect"  movements,  however,  have 
figured  so  prominently  of  recent  years  in  the  ex- 
change market  that  at  least  one  example  ought 
perhaps  to  be  given.  Far  and  away  the  most  im- 
portant of  such  "indirect  movements"  are  those 
in  which  gold  is  shipped  from  New  York  to  Paris 
for  the  sake  of  creating  a  credit  balance  in 
London. 

Before  examining  the  actual  figures  of  such 
an  operation  it  may  be  well  to  glance  at  the  theory 
of  the  thing.  A  New  York  banker,  say,  for  any 
one  of  many  different  reasons,  wants  to  create  a 
credit  balance  in  London.  Examining  exchange 
conditions,  he  finds  that  sterling  drafts  drawn  on 
London  are  to  be  had  relatively  cheaper  in  Paris 
than  in  New  York.  In  the  natural  course  of  ex- 
change arbitrage  the  New  York  banker  would 
therefore  buy  a  draft  on  Paris  and  send  it  to  his 
French  correspondent  with  instruction  to  use  it 
to  buy  a  draft  on  London  and  to  remit  such  draft 
to  London  for  credit  of  his  (the  American  bank- 
er's) account. 


FOREIGN    EXCHANGE  121 

But  exchange  on  Paris  is  not  always  plentiful 
in  the  New  York  market,  and  very  _K:ely  the 
New  York  banker  will  find  that  if  he  wants  to 
send  anything  to  Paris  he  will  have  to  send  gold. 
Assume,  then,  that  he  finds  conditions  favorable 
and  decides  to  thus  transfer  a  couple  of  hundred 
thousand  pounds  to  London  by  sending  gold  to 
Paris.    The  operation  might  work  out  as  follows : 

Cost  of  48,500  ounces  of  bar  gold  (.995  fine) 
at     U.     S.     Sub-Treasury,     New     York,     at 

$20.5684  per  ounce $997,567 

Insurance  (4^  cents  per  $100) 450 

Freight  (5-32  per  cent.) 1,555 

Assay  office  charges  (4  cents  per  $100)    400 

Cartage  and  packing 60 

Commission  in  Paris 250 

Interest  from  time  gold  is  shipped  from  New 
York  until  draft  on  new  credit  in  London  can 
be  safely  drawn  and  sold,  6  days  at  2  per 
cent 333 

$1,000,615 

The  gold  arrives  in  Paris  and  is  bought  by  the 
Bank  of  France — 

48,500  ounces  at  fcs.  106.3705  per  ounce,  equals 
fcs 5,158,969 

That  amount  of  francs  then  invested  in  a  check 
on  London,  and  the  check  sent  to  London  for 
credit  of  the  American  banker,  fcs.  5,158,969 
at  25  francs  10  centimes  per  £.  .  .  .  £205,536 

New  York  banker  sells  his  draft  on  London  for 

£205,536  at  4.86832 $1,000,615 


122  FOREIGN    EXCHANGE 

Conditions  principally  affecting  the  shipment 
of  gold  by  the  triangular  operation,  it  will  be 
seen  from  the  above  calculation,  are  the  rate  of 
exchange  on  London  at  New  York,  and  the  rate 
of  exchange  on  London  at  Paris.  The  higher  the 
rate  at  which  the  New  York  banker  can  sell 
his  bills  on  London  after  the  gold  has  been 
shipped,  the  more  money  he  will  make.  The 
lower  the  rate  at  which  his  Paris  agent  can  secure 
the  drafts  drawn  on  London,  the  greater  the 
amount  of  pounds  sterling  which  the  gold  will 
buy.  High  sterling  exchange  in  New  York  and 
low  sterling  exchange  in  Paris  are  therefore  the 
main  features  of  the  combination  of  circum- 
stances which  result  in  these  "triangular  opera- 
tions." 

Gold  Shipments  to  Argentina 

Of  the  man}^  other  ways  in  which  gold  moves, 
one  way  seems  to  be  becoming  so  increasingly 
important  that  it  is  well  worthy  of  attention. 
Reference  is  made  to  the  shipment  of  gold  from 
New  York  to  the  Argentine  for  account  of  Eng- 
lish bankers  who  have  debts  to  discharge  there. 

Owing  to  Argentine  loans  placed  in  the  Eng- 
lish market  and  to  heavy  exports  of  wheat,  hides, 


FOREIGN    EXCHANGE  123 

and  meat  from  Buenos  Aires  to  London,  there 
exists  almost  a  chronic  condition  of  indebtedness 
on  the  part  of  the  London  bankers  to  the  bankers 
in  the  Argentine.  Not  offset  by  any  correspond- 
ing imports,  these  conditions  are  putting  Buenos 
Aires  each  year  in  a  better  and  better  condition 
to  make  heavy  demands  upon  London  for  gold, 
demands  which  have  recently  grown  to  such  an 
extent  as  to  make  serious  inroads  on  the  British 
banks'  reserves.  Unwilling  to  comply  with  this 
demand  for  gold,  the  powers  in  charge  of  the 
London  market  have  on  several  occasions  delib- 
erately produced  money  conditions  in  London 
resulting  in  a  shifting  of  the  Argentine  demand 
for  gold  upon  New  York.  The  means  by  which 
this  has  been  accomplished  has  been  the  raising  of 
the  Bank  of  England  rate  to  a  point  sufficiently 
high  to  make  the  dollar-exchange  on  New  York 
fall.  Able,  then,  to  buy  dollar-drafts  on  New 
York  very  cheaply,  the  London  bankers  send  to 
New  York  large  amounts  of  such  drafts,  with 
instructions  that  they  be  used  to  buy  gold  for 
shipment  to  the  Argentine. 

The  very  general  confusion  of  mind  regarding 
these  operations  in  gold  comes  perhaps  from  the 
fact  that  they  are  constantly  referred  to  as  being 
a  result  of  Irigh  exchange  on  London,  at  New 


124  FOREIGN    EXCHANGE 

York.  Which  is  true,  but  a  most  misleading  way 
of  expressing  the  fact  that  low  exchange  on  New 
York,  at  London,  is  the  reason  of  the  shipments. 
High  sterling  exchange  at  New  York  and  low 
dollar-exchange  at  London  are,  of  course,  one 
and  the  same  thing.  But  in  this  case,  what  counts 
is  that  dollar-exchange  can  be  cheaply  bought  in 
London. 

No  attempt  is  made  in  this  little  work  to  cover 
the  whole  field  of  operations  in  gold,  infinite  in 
scope  as  they  are  and  of  every  conceivable  variety. 
But  from  the  examples  given  above  it  ought  to 
be  possible  to  work  out  a  fairly  clear  idea  as  to 
why  gold  exports  and  imports  take  place  and  as 
to  what  the  conditions  are  which  bring  them 
about. 

While  not  failing  to  realize  the  importance  to 
the  markets  of  the  movement  back  and  forth  of 
great  amounts  of  gold,  it  may  nevertheless  be  said 
that  from  the  standpoint  of  the  foreign  exchange 
business  the  importance  of  transactions  in  gold  is 
very  generally  overestimated.  Most  dealers  in 
foreign  exchange  steer  clear  of  exporting  or  im- 
porting gold  whenever  they  can,  the  business 
being  practically  all  done  by  half-a-dozen  firms 
and  banks.  As  has  been  seen,  the  profit  to  be 
made  is  miserably  small  as  a  rule,  while  the  trou- 

> 


FOREIGN    EXCHANGE  125 

ble  and  risk  are  very  considerable.  Import  op- 
erations, especially,  tie  up  large  amounts  of  ready 
capital  and  often  throw  the  regular  working  of  a 
foreign  department  out  of  gear  for  days  and  even 
weeks.  There  is  considerable  newspaper  adver- 
tising to  be  had  by  being  always  among  the  first 
to  ship  or  bring  in  gold,  but  there  are  a  good  many 
houses  who  do  not  want  or  need  that  kind  of  ad- 
vertising. Some  of  the  best  and  strongest  bank- 
ing houses  in  New  York,  indeed,  make  it  a  rule  to 
have  nothing  to  do  with  operations  in  gold  one 
way  or  the  other.  Should  they  need  drafts  on  the 
other  side  at  a  time  when  there  are  no  drafts  to  be 
had,  such  houses  prefer  to  let  some  one  else  do 
the  gold-shipping  and  are  willing  to  let  the  ship- 
ping house  make  its  one-sixteenth  of  one  per  cent, 
or  one-thirty-second  of  one  per  cent,  in  the  rate 
of  exchange  it  charges  for  the  bills  drawn  against 
the  gold. 

Particular  attention  has  been  paid  all  through 
the  foregoing  chapter  to  the  gold  movement  in 
its  relation  to  the  New  York  markets,  the  move- 
ment between  foreign  points  being  too  big  a  sub- 
ject to  describe  in  a  work  of  this  kind.  In  gen- 
eral, however,  it  can  be  said  that  of  the  three  great 
gold  markets  abroad,  London  is  the  only  one 
which  can  in  any  sense  be  called  "free."    In  Paris, 


120  FOREIGN    EXCHANGE 

the  ability  of  the  Bank  of  France  to  pay  its  notes 
in  silver  instead  of  gold  makes  it  possible  for  the 
Bank  of  France  to  control  the  gold  movement 
absolutely,  while  in  Germany  the  paternalistic 
attitude  of  the  government  is  so  insistent  that 
gold  exports  are  rarely  undertaken  by  bankers 
except  with  the  full  sanction  of  the  governors  of 
the  Reichsbank. 

It  is  a  question,  even,  whether  London  makes 
good  its  boast  of  maintaining  Europe's  only 
"free"  gold  market.  The  new  gold  coming  from 
the  mines  does,  it  is  true,  find  its  way  to  London, 
for  the  purpose  of  being  auctioned  off  to  the  high- 
est bidder,  but  as  the  kind  of  bids  which  can  be 
made  are  governed  so  largely  by  arbitrary  action 
on  the  part  of  the  Bank  of  England,  it  is  a  ques- 
tion whether  the  gold  auction  can  be  said  to  be 
"free."  Suppose,  for  instance,  that  the  "Old  Lady 
of  Threadneedle  Street"  decides  that  enough 
gold  has  been  taken  by  foreign  bidders  and  that 
exports  had  better  be  checked.  Instantly  the 
bank  rate  goes  up,  making  it  harder  for  the  rep- 
resentatives of  the  foreign  banks  to  bid.  Should 
the  rise  in  the  rate  not  be  sufficient  to  affect  the 
outside  exchange  on  London,  the  Bank  will 
probably  resort  to  the  further  expedient  of  enter- 
ing the  auction  for  its  own  account  and  outbid- 


FOREIGN    EXCHANGE  127 

ding  all  others.  Not  having  any  shipping  charges 
to  pay  on  this  gold  it  buys,  the  Bank  is  usually 
able  to  secure  all  the  gold  it  wants — or,  rather,  to 
keep  anybody  else  from  securing  it.  The  auction 
is  open  to  all,  it  is  true,  but  being  at  times  con- 
ducted under  such  circumstances,  is  hardly  a  mar- 
ket which  can  be  called  "free." 

If  there  is  any  "free"  gold  market  in  the 
world,  indeed,  it  is  to  be  found  in  the  United 
States.  All  anybody  who  wants  gold,  in  this 
country,  has  to  do,  is  to  go  around  to  the  nearest 
sub-treasury  and  get  it.  If  the  supply  of  bars  is 
exhausted,  the  buyer  may  be  disappointed,  but 
that  has  nothing  to  do  with  any  restriction  on  the 
market.  The  market  for  gold  bars  in  the  United 
States  is  at  the  Treasury  and  the  various  sub- 
treasuries,  and  as  long  as  the  prospective  buyer 
has  the  legal  tender  to  offer,  he  can  buy  the  gold 
bars  which  may  be  on  hand.  And  at  a  fixed 
price,  regardless  of  how  urgent  the  demand  may 
be,  who  he  is,  or  who  else  may  be  bidding.  First 
come  first  served  is  the  rule,  and  a  rule  which  is 
observed  as  long  as  the  bars  hold  out.  After  that, 
whoever  still  wants  gold  can  take  it  in  the  form  of 
coin. 

How  such  conditions  have  worked  out,  so  far 
as  our  gaining  or  losing  gold  is  concerned,  can  be 


128  FOREIGN    EXCHANGE 

seen  from  the  following  table,  introduced  here 
for  the  purpose  of  giving  a  clear  idea  as  to  just 
where  the  United  States  has  stood  in  the  interna- 
tional movement  of  gold  during  the  five-year 
period  given  below: 

Exports  of  Excess  of 

Gold  from  U.  S.  Imports  Imports 

1917 $371,883,884  $552,454,374  $180,570,490 

1916 90,249,548  491,009,301  403,759,753 

1915 146,224,148  171,568,755  25.344,607 

1914 112,038,529  66,538,659  *45,499,870 

1913 77,762,622  69,194,025  *8,568,597 

1912 57,328,348  48,936,500  *8,391,848 

*Excess  of  exports 

In  conclusion,  it  may  be  said  that  the  predic- 
tion that  as  international  financial  relationships 
between  banks  are  drawn  closer,  gold  movements 
will  tend  to  decrease,  seem  hardly  to  be  borne  out 
by  the  figures  of  the  table  given  above.  Banks 
here  and  banks  abroad  are  working  together  in  a 
way  unknown  ten  or  even  five  years  ago,  but  as 
yet  there  are  no  signs  of  any  lessening  in  the  in- 
ward or  outward  movement  of  specie.  More  lib- 
eral granting  of  international  credits,  increased 
international  loaning  operations,  far  from  put- 
ting an  end  to  the  physical  movement  of  gold  in 
large  quantities, — these  are  influences  tending  to 


FOREIGN    EXCHANGE  129 

make  gold  move  more  freely  than  ever.  The  day 
of  the  treasure  galleons  is  over,  but  in  their  place 
we  have  swift-moving  steamers  by  which  gold  can 
be  shifted  from  one  point  to  another  with  safety 
and  ease.  Gold  movements  seem  as  though  they 
were  to  play  an  important  part  in  the  markets  for 
a  good  many  years  to  come. 


CHAPTER    VIII 

FOREIGN  EXCHANGE  IN  ITS  RELA- 
TION  TO   INTERNATIONAL 
SECURITY  TRADING 

ON  account  of  the  huge  fixed  investment  of 
foreign  money  in  the  United  States,  on 
account  of  Europe's  continuous  specula- 
tive interest  in  our  markets,  and  the  activity  of 
the  "arbitrageurs"  in  both  bonds  and  shares,  deal- 
ings in  securities  between  ourselves  and  the  Old 
World  are  always  on  a  very  great  scale.  Not  in- 
frequently, indeed,  Europe's  position  on  Ameri- 
can securities  is  an  influence  of  dominating  im- 
portance. 

From  the  maturities,  refunding  operations,  and 
interest  remittances  alone,  growing  out  of  the 
permanent  investment  of  foreign  money  in  our 
securities,  there  results  a  very  great  amount  of 
international  security  and  exchange  business. 
Whether  Europe's  investment  here  amounts  to 
three  billions  or  four  billions  or  five  billions,  it  is 
impossible  to  say;  the  fact  remains  that  it  is  so 
large  that  every  year  a  very  great  amount  of 
foreign-held  bonds  come  due  and  have  to  be  paid 
off  or  refunded,  and,  further,  that  the  remitting 

130 


FOREIGN    EXCHANGE  131 

abroad  of  coupon  and  dividend  money  each  year 
calls  for  upward  of  $150,000,000. 

This  matter  of  maturing  investments,  alone, 
calls  for  continuous  international  security  trading 
and  on  a  large  scale.  Each  year  there  comes  due 
in  this  country  an  amount  of  railroad  and  other 
bonds  running  well  up  into  the  hundreds  of  mil- 
lions, of  which  a  large  proportion  are  held  on  the 
other  side.  Some  of  these  maturities  are  paid  off 
in  cash — more  often,  refunding  bonds  are  offered 
in  exchange ;  seldom,  indeed,  are  the  maturing  in- 
vestments allowed  to  remain  unreplaced.  Euro- 
pean investors,  especially,  have  consistently  done 
well  with  money  placed  in  this  country,  and  the 
running  off  to  maturity  of  a  foreign-held  Ameri- 
can bond  is  nearly  sure  to  be  followed  up  by  re- 
placement with  some  other  American  security. 

Bond  houses  doing  an  international  business 
are  therefore  keenly  watchful  of  the  maturity  of 
issues  largely  held  abroad,  and  are  ever  ready 
with  offers  of  new  and  attractive  investments. 
Knowledge  of  the  location  of  American  invest- 
ments in  Europe  is  thus  a  business  asset  of  the 
greatest  importance,  and  records  are  carefully 
kept.  The  fact  that  a  dealer  here  knows  that 
some  bank  in  London  has  a  wealthy  client  who 
holds  a  big  block  of  certain  bonds  about  to  ma- 


132  FOREIGN    EXCHANGE 

ture,  may  very  possibly  mean  that  the  house  here 
may  be  able  to  make  a  very  profitable  trade.  In- 
formation of  this  character  is  carefully  gathered 
wherever  possible  and  as  carefully  guarded.  The 
longer  a  house  has  been  in  business,  naturally, 
and  the  closer  its  financial  relationship  with  in- 
vestment interests  abroad,  the  more  of  this  sort 
of  information  it  is  bound  to  possess. 

Foreign  exchange  growing  out  of  these  renew- 
als and  refundings  is  on  a  very  large  scale. 
Sometimes  the  placing  of  a  new  issue  abroad 
means  such  immediate  drawing  of  drafts  on 
foreign  buyers  of  the  securities  as  to  depress  the 
exchange  market  sharply.  Sometimes,  as  in  the 
case  of  new  issues  of  railroad  stock,  where  }>&y- 
ments  are  usually  made  in  instalments  covering 
a  year  or  more,  the  drawing  of  exchange  is  dis- 
tributed in  such  a  way  that  its  influence,  if  felt 
at  all,  is  felt  merely  as  an  underlying  element  of 
weakness. 

Of  a  somewhat  different  character  are  the  for- 
eign exchange  transactions  originating  from  what 
might  be  called  Europe's  "floating"  investment 
in  American  securities  and  from  the  out-and-out 
speculations  carried  on  in  this  market  by  the  for- 
eigners. 

There  is  never  a  time,  probably,  when  the  float- 


FOREIGN    EXCHANGE  133 

ing  foreign  investment  in  American  stocks  and 
bonds  does  not  run  up  with  the  hundreds  of  mil- 
lions of  dollars.  "Speculation,"  such  operations 
would  probably  be  called  by  many  people,  but 
whether  speculation  or  not,  a  form  of  activity 
which  is  continually  giving  rise  to  big  dealings 
in  foreign  exchange.  For  this  "floating"  invest- 
ment is  very  largely  for  account  of  bankers 
whose  international  connections  and  credit  make 
it  possible  for  them  to  carry  stocks  and  bonds 
through  the  agency  of  the  exchange  market,  and 
without  having  to  put  up  any  actual  money. 
The  ingenious  method  by  which  this  is  accom- 
plished is  about  as  follows : 

A  banker  here,  for  instance,  decides  that  a  cer- 
tain low-priced  bond  is  cheap  and  that  if  pur- 
chased it  will  show  a  substantial  profit  within 
six  months  or  a  year.  Not  wanting  to  buy  the 
bonds  and  borrow  on  them  here,  he  invites  his  for- 
eign correspondent  into  the  deal  on  joint  ac- 
count, arranging  to  raise  the  money  with  which 
to  buy  the  bonds  by  drawing  a  ninety-day  sight 
draft  on  the  foreign  correspondent.  This  he 
does,  drawing,  say,  a  £50,000  draft  at  ninety 
days'  sight,  and  selling  it  in  the  exchange  market 
at,  let  us  say,  $4.83. 

The  $241,500  received  from  the  sale  of  the 


134  FOREIGN    EXCHANGE 

draft,  the  American  banker  uses  to  buy  the  bonds. 
Ninety  days  later  the  draft  will  come  due  in  Lon- 
don, and  have  to  be  covered  (or  renewed)  from 
this  side,  but  in  the  meantime,  a  profitable  chance 
to  sell  the  bonds  may  present  itself.  If  not,  the 
draft  can  be  "renewed"  at  the  end  of  the  ninety 
days,  and  again  and  again  if  necessary,  until  the 
bankers  are  willing  to  close  out  the  bonds. 

This  operation  of  "renewing"  long  drafts 
drawn  for  the  purpose  of  carrying  securities  is 
one  of  the  most  interesting  phases  of  foreign  ex- 
change business  in  connection  with  international 
security  dealings.  The  draft  has  been  drawn, 
say,  for  .£50,000.  The  end  of  the  ninety-day 
period  comes,  the  draft  is  due,  is  presented,  and 
has  to  be  paid.  But  the  bankers  do  not  choose  to 
sell  out  the  bonds  and  close  the  deal.  They  ar- 
range instead  to  renew  the  maturing  draft.  This 
they  do  by  paying  the  original  ninety-day  draft 
out  of  the  proceeds  of  a  new  ninety-day  draft. 

The  original  draft  for  £50,000  comes  due  let 
us  say  on  October  19,  so  that  about  October  10th 
the  New  York  banker  will  be  under  the  necessity 
of  sending  over  to  London  a  demand  draft  for 
£50,000.  The  rate  realizable  for  ninety-day  drafts 
being  always  considerably  lower  than  the  price  of 
demand  drafts,  it  follows  that  if  the  banker  pro- 


FOREIGN    EXCHANGE  135 

poses  to  buy  £50,000  of  demand  out  of  the  pro- 
ceeds of  a  fresh  ninety-day  bill  he  will  have  to 
draw  his  fresh  bill  for  more  than  £50,000.  If 
the  demand  rate  happened  to  be  4.86,  the  £50,000 
he  needs  would  cost  him  $243,000.  In  order  to 
raise  $243,000  by  selling  a  ninety-days'  sight 
draft  (say  at  4.83)  he  would  have  to  make  the 
new  draft  for  £50,310.  The  extra  £310  would 
constitute  the  interest.  Each  time  he  renewed 
the  draft  he  would  have  to  draw  for  more  and 
more. 

Requiring  the  tying  up  of  no  actual  capital, 
this  form  of  financing  "floating  investments"  has 
become  exceedingly  popular  and  is  carried  on  on 
a  large  scale.  Where  the  relationships  between 
the  foreign  and  the  American  houses  are  close, 
there  is  almost  no  limit  to  the  number  of  times  an 
original  bill  may  be  renewed.  As  for  the  con- 
stantly increasing  amount  of  the  drafts  which 
have  to  be  drawn,  that  is  taken  care  of  by  the  in- 
terest on  the  investment  carried. 

Not  all  the  floating  investment  in  American 
securities  is  carried  in  this  way,  but  in  whatever 
form  the  financing  is  done  it  is  bound  to  involve 
foreign  exchange  operations  and  to  necessitate 
the  drawing  of  drafts  by  banking  houses  in  this 
country  on  their  correspondents  abroad.     Quiet 


136  FOREIGN    EXCHANGE 

conditions  may  result  in  long  periods  when  in- 
vestments of  this  kind  are  left  undisturbed,  but 
even  then,  the  constant  remitting  and  renewing  of 
drafts  originates  a  good  deal  of  exchange  market 
activity.  And  with  considerable  frequency  oc- 
cur periods  when  the  floating  investment  is 
strongly  affected  by  immediate  conditions,  and 
when  purchases,  sales,  and  transfers  of  securities 
stir  the  exchange  market  to  a  high  pitch  of  excite- 
ment. 

Speculative  operations  in  this  market  for  for- 
eign account,  are,  however,  the  cause  of  the  great- 
est amount  of  exchange  market  activity  caused 
by  international  security  transactions.  There 
are  times,  as  has  been  said,  when  individuals  and 
banking  houses  abroad  speculate  heavily  and  con- 
tinuously in  this  market,  at  which  times  the  ex- 
change market  is  strongly  affected  by  the  buying 
and  selling  of  exchange  which  necessarily  takes 
place.  Such  periods  may  last  for  weeks  or  even 
months,  and  during  all  of  the  time,  London's 
immediate  attitude  toward  the  market  is  apt  to 
be  the  controlling  influence  on  the  movement  of 
exchange  rates. 

Concerning  arbitraging  in  stocks,  operations 
of  this  kind  will  be  found  to  divide  themselves 
readily  into  two  classes — trades  which  are  closed 


FOREIGN    EXCHANGE  137 

off  at  both  ends  at  once,  and  trades  which  are  al- 
lowed to  run  over  night  or  even  for  a  day  or  two. 
The  former  is  a  class  of  business  out  of  which  a 
dozen  or  twenty  well-equipped  houses  in  New 
York  are  making  a  great  deal  of  money.  With 
an  expert  "at  the  rail"  on  the  floor  of  the  New 
York  Stock  Exchange,  and  continuous  quota- 
tions as  to  prices  on  the  various  stock  exchanges 
in  Europe  coming  in,  these  houses  are  in  a  posi- 
tion to  take  advantage  of  the  slightest  disparity 
in  prices.  The  chance  to  buy  a  hundred  shares 
of  some  stock,  in  London,  for  instance,  and  to 
sell  it  out  at  the  same  time  in  New  York,  at  one- 
eighth  or  one-quarter  more,  is  what  the  arbi- 
trageurs are  constantly  on  the  lookout  for.  With 
the  proper  facilities,  an  expert,  in  the  course  of 
the  hour  during  which  the  London  and  New 
York  Stock  Exchanges  are  simultaneously  in  ses- 
sion, is  often  able  to  put  through  a  number  of 
profitable  trades. 

Such  operations  are  possible,  primarily,  because 
of  the  fact  that  the  same  influences  affect  differ- 
ent markets  in  different  ways.  A  piece  of  news 
which  might  cause  a  little  selling  of  some  stock 
in  London,  for  instance,  might  have  exactly  the 
opposite  effect  in  New  York.  With  the  wires 
continually  hot  between  the  two  markets  and  a 


138  FOREIGN    EXCHANGE 

number  of  experts  on  the  watch  for  the  chance 
to  make  a  fraction,  quotations  here  and  abroad 
can  hardly  get  very  far  apart,  at  least  in  the  ac- 
tive issues,  but  occasionally,  it  does  happen  that 
the  arbitrageur  is  able  to  take  advantage  of  a 
substantial  difference.  Always  without  risk,  the 
bid  in  one  market  being  in  hand  before  the  stock 
is  bought  in  the  other  market. 

But  not  so  in  the  case  of  the  other  kind  of  ar- 
bitrage, where  stocks  bought  in  one  market  are 
carried  over  night  for  the  sake  of  selling  them  out 
in  some  other  market  the  next  morning.  There 
a  decided  risk  is  taken,  the  success  of  the  opera- 
tion depending  absolutely  upon  the  judgment  of 
the  operator.  Under  the  stimulus  of  some  favor- 
able development,  for  instance,  which  becomes 
known  here  only  after  the  Stock  Exchanges 
abroad  are  closed  for  the  day,  the  New  York  mar- 
ket closes  buoyant.  The  chances  are  that  the  re- 
ceipt of  the  news  abroad  over  night  will  make  the 
London  market  open  up  strong  in  the  morning. 
To  buy  stock  right  at  the  closing  of  the  market 
here  for  the  purpose  of  selling  it  out  next  morn- 
ing in  London  at  the  opening  is  an  operation  not 
without  risk,  but  one  which  is  likely  to  make 
money.  A  lower  opening  abroad  would,  of 
course,  spoil  the  whole  plan,  and  force  a  loss,  but 


FOREIGN    EXCHANGE  139 

just  there  comes  in  the  ability  and  judgment  of 
the  man  who  is  handling  the  business.  His  judg- 
ment need  by  no  means  be  infallible  for  the  house 
to  make  a  great  deal  of  money. 

Concerning  arbitraging  in  bonds,  practically 
everything  depends  not  only  on  the  judgment 
and  skill,  but  on  the  facilities  and  connections  of 
the  man  in  charge.  In  the  great  "open"  mar- 
ket in  New  York  and  in  the  great  "open"  market 
in  London,  American  bonds  are  being  continually 
bid  for  and  offered  in  a  way  which  gives  an  expert 
in  touch  with  both  markets  a  chance  to  buy  here 
and  sell  there,  or  vice  versa,  at  a  profit.  Such  men 
are  employed  by  bond  houses  with  international 
connections,  and  spend  their  time  doing  practic- 
ally nothing  else  but  keeping  in  close  touch  with 
open  market  bids  and  offers  for  stocks  and  bonds 
and  trying  to  buy  in  one  market  and  sell  in  an- 
other. Such  trades  are  frequently  put  through 
on  a  very  profitable  basis,  profits  of  a  clear  point 
or  more  being  not  at  all  uncommon. 

As  for  the  degree  of  risk  to  be  taken  in  busi- 
ness of  this  kind,  that  is  entirely  at  the  discretion 
of  the  arbitrageur.  Where  a  firm  bid  of  ninety- 
nine,  good  for  the  day,  for  instance,  is  given,  there 
is  no  risk  in  cabling  a  bid  of  ninety-eight  to  Lon- 
don, but  where  the  bid  is  not  firm  at  all,  or  where 


140  FOREIGN    EXCHANGE 

it  is  only  firm  for  five  minutes,  or  in  many  other 
cases,  the  man  who  cables  his  own  bid  of  ninety- 
eight  is  taking  a  certain  amount  of  risk.  Often 
enough  he  gets  the  bonds  in  London  at  ninety- 
eight,  only  to  find  that  the  ninety-nine  bid  in  New 
York  has  been  withdrawn. 

Knowledge  of  what  risks  to  take  and  of  what 
risks  to  leave  alone  constitutes  expertness  in  this 
line  of  business.  Seldom  can  the  transaction  be 
absolutely  closed  at  both  ends  and  any  substantial 
profit  be  made.  Most  of  the  time  the  correctness 
of  the  bond  expert's  judgment  as  to  how  he  can 
sell  somewhere  else  what  he  has  bought,  is  what 
determines  the  amount  of  money  he  will  make 
or  lose. 


CHAPTER    IX 

THE  FINANCING  OF  EXPORTS  AND 
IMPORTS 

INTERESTING  as  the  movement  of  gold 
and  the  international  money  markets  may  be, 
it  is  in  its  application  to  the  every-day  im- 
porting and  exporting  of  merchandise  that  for- 
eign exchange  has  its  greatest  interest  for  the 
greatest  number  of  people.  Every  bale  of  cotton 
exported  from  the  country,  every  pound  of 
coffee  brought  in,  is  the  basis  of  an  operation  in 
foreign  exchange,  such  operations  involving 
usually  the  issue  of  what  is  known  as  "commer- 
cial credits." 

Broadly  speaking,  commercial  credits  are  of 
two  classes,  those  issued  to  facilitate  the  import 
of  merchandise  and  those  issued  to  facilitate  its 
export.  Considering  the  question  from  the  stand- 
point of  New  York,  import  credits  are  so  much 
more  important  than  export  credits  and  issued 
in  so  much  larger  volume,  they  will  be  taken  up 
first. 

Not  all  the  merchandise  imported  into  the 
United  States  is  brought  in  under  commercial 

141 


142 


FOREIGN    EXCHANGE 


<&~AlA*  /JO/ 


Mfr* 


Guaranty  Trust  Company  of  NewYbrk 


,  AzZfaJs       @e&£**  '*    4&f 


tirtC-  GuarantyTrust  Company  of  NewYork 
33  Lombard  Street. 

London 

;>)/>/n//'Mf/y>t}/*i:)t//i?y///>//fl>y/i/  /nay  fc/ain&fr/tyL£d*a^*t>ri1lkn{t 


jtHdfJ  //Uirt£f/U4'  paOU^Bn ■  u#ua/. y  --*?**■*-£  t  'r?,-iv\/f 


f/1  /i/,yJum  rtJumJ/tct 


;  4ntmss//Yii/sjf  /n  -&4L*.  sijl~ — -aU^tls.  *    4r,Ar//uiuAaJfa$ 


!imii.UA//l/Ju-n/ny       -£!a~-C~~—  , 


__ * <W<T  J/'-Misy/HLf/rs/y-y:       %k^^_     i<ho 

/Mu/du/rux-'Mu-lff/'ati  •rn  '&■ «*v/ !/ft^U^^a//in'//^y^a^^cnJ^fW£i^^^a/xprr^maf 

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sdU/sa,  s.ir/yrf/w  d/n/frtt.1  fo./fcy''fJ&''nrwHQ.i/fo 

/^//u-.J/K/ZirAUi/i  aivfriv  ft'mn/<rtw/sum-J:/r '/rw1  /fyy/y./Htwcffti/fist/v&riybei 

s/*uun:uiu/rffrru/sn4V/^/Mttf£://ijA'//ujf 
^y>iffcn/h/urt/afa<*riqffi*,'tn-6zw'r4m/ 


^«amn^Jut^^c*>^t^^/^/&i^C^r^/\ 


■AM  ^^^4^m^»H^W 
Mndbr&anm/y&nci/'  £&rtfumu/qf7/M/J/vr& 

Form  of  Commercial  Letter  of  Credit 


FOREIGN    EXCHANGE  143 

letters  of  credit,  but  that  is  coming  to  be  more 
and  more  the  way  in  which  payment  for  imports 
is  being  arranged.  Formerly  an  importer  who 
had  bought  silk  or  white-goods  in  France  went 
around  to  his  banker,  bought  a  draft  on  Paris  for 
the  required  amount  of  francs  and  sent  that  over 
in  payment.  In  some  cases  that  is  still  the  method 
by  which  payment  is  made,  but  in  the  very  great 
majority  of  cases  where  the  business  is  being  run 
on  an  up-to-date  basis,  a  commercial  letter  of 
credit  is  arranged  for  before  the  importation  is 
made.  Of  how  great  advantage  such  an  arrange- 
ment is  to  the  merchant  importing  goods  the  fol- 
lowing practical  illustration  of  how  a  "credit" 
works  will  show. 

To  exemplify  the  greatest  number  of  points  of 
importance  possible  in  connection  with  the  com- 
mercial credit  business,  the  case  of  a  shipment  of 
raw  silk  from  China  will,  perhaps,  serve  best. 
A  silk  manufacturer  in  Paterson,  New  Jersey, 
we  will  assume,  has  purchased  by  cable  ten  bales 
of  raw  silk  in  Canton,  China.  Understanding  of 
the  successive  steps  in  the  financing  of  such  a 
transaction  will  mean  a  pretty  satisfactory  un- 
derstanding of  the  general  principles  under  which 
the  financing  of  most  of  our  imports  is  arranged. 

The  purchase  of  the  silk  having  been  consum- 


144  FOREIGN    EXCHANGE 

mated  by  cable,  the  first  thing  the  purchaser 
would  do  would  be  to  go  to  his  banker  in  New 
York,  lay  before  him  an  exact  statement  of  the 
conditions  under  which  the  purchase  was  made, 
and  get  him  (the  banker)  to  open  a  commercial 
letter  of  credit  covering  those  terms.  Such  a 
credit,  of  which  a  reprint  is  given  herewith,  would 
be  in  the  form  of  a  letter  to  the  issuing  banker's 
London  correspondent,  requesting  him  to  "ac- 
cept" the  drafts  of  the  sellers  of  the  silk  in  Can- 
ton up  to  a  certain  amount  and  under  certain  con- 
ditions. These  conditions,  having  to  do  with  the 
"usance"  of  the  drafts  (whether  they  were  to  be 
drawn  at  three,  four,  or  six  months'  sight)  and 
with  the  shipping  documents  to  accompany  the 
drafts,  are  all  very  fully  set  forth  in  the  letter  of 
credit  itself.  If  the  silk  has  been  bought  on  the 
basis  of  four  months,  for  instance,  the  credit 
would  read  that  drafts  are  to  be  drawn  at  four 
months'  sight.  Mention  is  also  made  as  to  whose 
order  the  bills  of  lading  are  to  be  made,  as  to 
where  the  insurance  is  to  be  effected,  etc.,  etc. 

The  silk  importer  having  received  this  letter  of 
credit  from  the  banker  in  New  York,  sends  it  by 
first  mail  (or,  if  the  case  be  urgent,  cables  its  con- 
tents) to  the  seller  of  the  silk  out  in  Canton.  The 
latter,  having  received  it,  is  then  in  a  position  to  go 


FOREIGN    EXCHANGE  145 

ahead  with  his  shipment.  The  first  thing  he  does 
is  to  put  the  silk  aboard  ship,  receiving  from  the 
steamship  company  a  receipt  (bill  of  lading) 
stating  that  the  ten  bales  have  been  put  aboard, 
and  making  them  deliverable  to  the  order  of  the 
banker  in  New  York,  who  issues  the  credit.  The 
bill  of  lading  being  made  out  to  his  order  is  use- 
less to  anybody  else.  He  and  he  only  can  get  the 
silk  out  of  the  ship  when  it  arrives  in  New  York. 

The  shipper  in  Canton  having  received  this  bill 
of  lading  from  the  steamship  company  and  hav- 
ing properly  insured  the  goods  and  received  a 
certificate  stating  that  he  has  done  so,  is  then  in  a 
position  to  go  ahead  and  draw  his  draft  for  the 
cost  of  the  silk.  The  London  correspondent  of 
the  New  York  banker,  to  whom  the  letter  of 
credit  is  addressed,  is,  say,  the  Guaranty  Trust 
Company  of  London.  Upon  that  institution  the 
Canton  silk  firm,  therefore,  draws  his  draft  in 
pounds  sterling  for  the  cost  of  the  silk,  attaching 
to  the  draft  the  bill  of  lading,  an  invoice,  and  the 
insurance  certificate. 

A  pertinent  inquiry  at  this  point  is  as  to  why 
the  letter  of  credit  for  silk  shipped  from  a  city  in 
China  directs  that  drafts  be  drawn  on  London — 
as  to  why  London  figures  in  the  transaction  at 
all?    The  answer  is  that  drafts  on  London  are 


146  FOREIGN    EXCHANGE 

always  readily  negotiable,  and  that  London  is  the 
only  city  in  the  whole  world  drafts  on  which  are 
readily  negotiable  in  all  places  and  at  all  times. 
A  draft  on  New  York  or  on  Berlin  might  be 
negotiated  at  a  point  like  Canton,  but  to  be  sure 
that  the  exporter  of  the  silk  will  get  the  best  rate 
of  exchange  for  his  drafts,  the  drafts  must  be 
drawn  on  London,  the  financial  center  of  the 
world.  One  of  the  chief  points  to  the  whole  busi- 
ness of  taking  out  a  credit,  in  fact,  is  to  provide 
a  point  on  which  the  shipper  can  draw  satisfac- 
torily. 

Assume  now  that  the  silk  has  been  put  aboard 
ship  bound  for  the  United  States,  that  the  ship- 
per has  drawn,  say,  a  draft  for  <£l,000  at  four 
months'  sight  on  the  Guaranty  Trust  Co.,  Lon- 
don, and  has  attached  thereto  the  bill  of  lading 
and  the  insurance  certificate.  Taking  this  draft 
around  to  his  bank  the  shipper  sells  it  for  local 
currency  at  the  then  prevailing  rate  for  four 
months'  sight  drafts  drawn  on  London.  The  fact 
that  it  is  drawn  at  four  months'  sight  means  that 
he  will  get  a  lower  rate  of  exchange  for  it  than  if 
it  were  drawn  payable  on  demand,  but  that  was 
the  arrangement  with  the  buyer  in  New  York — 
that  the  drafts  against  the  silk  were  to  have  four 
months  to  run. 


FOREIGN    EXCHANGE  147 

Having  sold  this  draft  to  his  bank  in  Canton 
and  received  local  currency  therefor,  the  shipper 
of  the  silk  is  out  of  the  transaction.  He  has 
shipped  the  goods  and  he  has  his  money.  What 
becomes  of  the  draft  he  drew  is  the  next  impor- 
tant point  to  consider.  But  so  far  as  the  ex- 
porter is  concerned,  the  transaction  is  closed,  and 
he  is  ready  for  the  next  operation. 

The  silk  has  now  been  set  afloat  for  New  York, 
and  the  draft  purchased  by  the  Canton  banker  is 
on  its  way  to  London  for  acceptance.  Long  be- 
fore the  silk  gets  to  New  York  the  draft  will  have 
reached  London  and  will  have  been  presented  to 
the  cashier  of  the  Guaranty  Trust  Co.,  there, 
who,  of  course,  was  apprised  of  the  credit  opened 
on  his  bank  at  the  time  such  credit  was  originally 
issued  in  New  York.  Examining  the  draft  and 
the  documents  carefully  to  see  that  they  conform 
with  the  terms  of  the  credit,  the  cashier  of  the 
Guaranty  Trust  Co.,  London,  formally  "accepts" 
the  draft,  marking  it  payable  four  months  from 
the  date  it  was  presented  to  him.  The  accepted 
draft  he  hands  back  to  the  messenger  of  the  bank 
who  brought  it  in;  the  bill  of  lading,  insurance 
certificate,  and  invoice  he  keeps.  By  the  next 
mail  steamer  he  dispatches  these  papers  to  the 
banker  in  New  York  who  issued  the  credit. 


148  FOREIGN    EXCHANGE 

For  the  time  being,  at  least,  that  is  to  say,  till 
the  accepted  draft  comes  due,  the  London  banker 
is  out  of  the  transaction,  which  is  now  narrowed 
down  to  the  importer  of  the  silk  in  Paterson  and 
the  banker  in  New  York  who  issued  him  the 
credit. 

Assume  now  that  a  week  has  passed  and  that 
the  New  York  banker  finds  himself  in  possession 
of  a  bill  of  lading  for  ten  bales  of  silk,  merchan- 
dise deliverable  to  his  order.  A  few  days  later, 
perhaps,  the  goods  arrive  overland  by  fast  freight 
from  Seattle.  The  Paterson  silk  manufacturer, 
who  is  eagerly  awaiting  their  arrival,  comes 
around  to  the  banker:  "Endorse  over  the  bill  of 
lading  to  me,"  he  says,  "so  that  I  can  get  the  silk 
and  start  manufacturing  it." 

If  the  banker  does  it,  he  will  be  giving  over  the 
only  security  he  has  for  the  payment  at  maturity 
of  the  draft  his  London  correspondent  accepted, 
and  for  which  he  himself  is  responsible.  Still, 
the  manufacturer  has  to  have  his  silk. 

A  number  of  different  agreements  exist  be- 
tween bankers  and  importers  to  whom  the  bank- 
ers issue  credits,  as  to  the  terms  on  which  the  im- 
porters are  to  be  allowed  to  take  possession  of  the 
merchandise  when  it  arrives  here.  Sometimes  the 
goods  are  put  into  store  and  handed  over  to  the 


TRUST   RECEIPT. 


UmltreD  from  Tae  Guaranty  Trust  Co  op  New  York  the  following  goods  and  mer» 
chandise,  their  property,  specified  in  the  Bill  of  Lading  per  S.  S.  ../£i£i4*fr-/j&£3± 


patpH       /tl^CL-.l^    /ftrf  marked  and  Numbered  fts  follows 


S.y.Z.    /-'*• 


and,  in  consideration  thereof,  \ {  hereby  agree  to  hold  said  goods  in  trust  for  them. 

•we    I  ; 

and  as  their  property,  with  liberty  to  sell  the  same  for  their  account,  and  further  agree,  in  case 

of  sale  to  hand  the  proceeds  to  them  to  apply  against  the  acceptances  of  The  Guaranty  Trust 

Co.  of  New  York  on  J  — —  i  account,  under-the  terms  of  the  Letter  of  Credit  No.  _  /  30/ 
(    our   I  * 

issued  for  J    '"'    t  account  and  for  the  payment  of  any  other  indebtedness  of  1 [  to  Thb 

'    our    '  '  ours    > 

Guaranty  Trust  Co   of  New  York. 

The  Guaranty  Trust  Co    op  New   York   may  at  any  time  cancel  this  trust  and  take 

possession  of  said  goods  or  of  the  proceeds  of  such  of  the  same  as  may  then  have  been  sold. 

wherever  the  said  goods  or  proceeds  may  then  be  found  and  in  the  event  of  any   suspension. 

or  failure,  or  assignment  for  the  benefit  of  creditors,  on  \  — *~  [  part   or  of  the  non-fulfillment 

'    our    l 

of  any  obligation,  or  of  the  non-payment  at  maturity  of  any  acceptance  made  by  |  J  under 

'     us     ' 

said  credit,  or  under  any  otjiei'credit  issued  by  The  Guaranty  Trust  Co    of  New  York  on 

\ •  j  account  or  of  any  indebtedness  on  j  — —  J  part  to  them,  all  obligations,  acceptances. 

indebtedness  and  liabilities  whatsoever  shall  thereupon  (with  or  without  notice)  mature  and 
become  due  and  payable.  The  said  goods  while  in  |  ll'v  (  hands  shall  be  fuUy  insured  against 
loss  by  fire 

Dated.  New  York  City,  ^Z^    6      —       19  A» 


(Signed) . 


-^ 


OP    * * stg. 

Form  of  Trust  Receipt 


U) 


150  FOREIGN    EXCHANGE 

merchant  only  when  he  shows  that  he  has  sold 
them  and  needs  them  to  make  delivery.     Some- 

BAILEE  RECEIPT. 

3RrrriBP&  from  the  Guaranty  Trust  Company  of  New  York, 

solely  for  tlie  purpose  of  selling  same  for  account  of  said  Company  : 

0 

marked  and  numbered ^ClX^-=-  /"~  /Q ■ 


and -7-i~r  .I. hereby  undertake  to  sell  the  property  herein  specified,  for 

Account  of  the  said  Company,  and  collect  the  proceeds  of  the  sale  or  sales  thereof, 
and  deliver  the  same  immediately  on  receivt  thereof  to  the  said  Comvany,  to  be 
applied  to  the  credit  of  jV>» 

hereby  acknowledging  ^-T^j^A^f- _<o  be  Bailee  oftlie  said  property  for  the  said 

Company,  nnd.  ststrt. do  hereby  assign  and  transfer  to  the  said  Company 

the  accounts  of  the  purchaser  or  purchasers  of  said  property  to  the  extent  of  tlie 
purchase  price  tliereof,  of  which  fact  notice  shall  be  given  at  the  time  of  delivery  of 
the  said  property  by  ^^aA~to  such  purchaser  or  purchasers  and  all  invoices  therefor 
shall  have  imprinted,  written  or  stamped  thereon  by  -j42& the  folloiving : 

"Transferred  dnd  payable  to  GUARANTY  TRUST  COMPANY  OF  NEW 
¥0RK,  Nassau  and  Cedar  Streets,  New  York." 

If  the  said  property  is  not  sold  and  the  proceeds  so  deposited  within  ten  days 
from  this  date,  _^Zi£L— undertake  to  return  all  documents  at  once  on  demand,  or  to 
pay  the  value  of  the  goods,  at  the  Company's  option. 

The  said  goods  while  in  J  — —  ( hands  shall  be  fully  insured  against  loss  by  fire. 

The  terms  of  this  receipt  and  agreement  sliall  continue  and  apply  to  tlie  mer- 
chandise above  referred  to  whether  or  jwt  control  oftlie  same,  or  any  part  tliereof,  be 
at  any  time  restored  to  the  Guaranty  Trust  Company  of  New  York,  and  subsequently 
delivered  to  us.  -t^s  s  &£ 

Bated  at  New  York  City, S3i£±*^~^_A...~ 19 /Q. 


Form  of  Bailee  Receipt 


times  they  are  warehoused  at  once,  and  parcelled 
out  to  the  importer  only  in  small  lots,  as  he  needs 
them.    But  more  often  the  goods  are  delivered 


FOREIGN    EXCHANGE  151 

over  to  the  importer  on  his  signing  one  form  or 
other  of  what  is  known  as  a  "trust  receipt." 

Such  difference  of  opinion  exists  among  for- 
eign exchange  men  as  to  the  goodness  of  the  trust 
receipt  system  that  the  author  refrains  from  mak- 
ing comment  on  it,  confining  himself  strictly  to 
description  of  what  the  system  is.  As  will  be 
seen  from  the  accompanying  reprint  of  the  trust 
receipt  used  by  one  of  the  largest  issuers  of  com- 
mercial credits  in  the  country,  the  document  is 
simply  a  pledge  on  the  part  of  the  importer  to 
hold  the  merchandise  in  trust  for  the  banker,  and, 
as  the  merchandise  is  sold,  to  hand  over  the  pro- 
ceeds to  apply  against  the  draft  drawn  by  the 
shipper  of  the  goods.  The  theory  of  the  thing 
is  that  by  the  time  all  the  merchandise  has  been 
sold  more  than  enough  money  will  have  been 
handed  over  to  the  New  York  banker  to  take  care 
of  the  draft  accepted  by  his  London  correspon- 
dent, the  excess  constituting  the  importer's  profit. 

The  kind  of  trust  receipt  under  which  bankers 
are  willing  to  give  over  the  merchandise  (the  only 
collateral  they  have)  naturally  varies  according 
to  the  standing  of  the  house  in  question.  In  the 
case  of  some  importers  the  bankers  would  be 
willing  to  let  the  bill  of  lading  pass  out  of  their 
hands  on  almost  any  kind  of  a  receipt ;  in  the  case 


152  FOREIGN    EXCHANGE 

of  others  a  very  strict  and  binding  contract  is  in- 
variably signed.  But  whatever  the  form  of  the 
contract,  it  is  to  be  borne  in  mind  that  when  the 
banker  issuing  the  credit  hands  over  the  bill  of 
lading  to  the  importer  on  trust  receipt,  he  is  al- 
lowing the  only  security  he  has  to  pass  out  of  his 
hands,  and  is  putting  himself  in  the  position  of 
having  made  an  unsecured  loan  to  the  importer. 
Returning  now  to  the  particular  transaction  in 
question,  the  point  has  been  reached  where  the 
silk  is  in  the  importer's  hands,  that  result  having 
been  accomplished  without  the  importer  having 
put  up  a  cent  of  money.  Moreover,  for  nearly 
four  months  to  come  there  will  be  no  necessity  of 
the  importer's  putting  up  any  money  (unless  he 
should  sell  some  of  the  silk,  in  which  case  he  is 
bound  to  turn  over  the  money  to  the  New  York 
banker  as  a  "prepayment") .  But  in  the  ordinary 
course  of  events  the  importer  of  the  silk  has  near- 
ly the  four  full  months  in  which  to  fabricate  the 
goods  and  sell  them.  At  the  end  of  that  time  the 
draft  drawn  by  the  firm  in  Canton  and  accepted 
by  the  Guaranty  Trust  Co.,  London,  will  be  com- 
ing due,  and  the  silk  importer  will  be  under  the 
necessity  of  remitting  funds  to  meet  it.  Twelve 
days  before  the  actual  maturity  of  the  <£l,000 
draft  in  London,  the  New  York  banker  will  send 


FOREIGN    EXCHANGE  153 

to  the  manufacturer  in  Paterson  a  memorandum 
for  £1,000  at,  say,  4.86  (whatever  is  the  current 
rate)  plus  commission.  The  silk  firm  pays  in 
dollars ;  the  New  York  banker  uses  the  dollars  to 
buy  a  demand  draft  for  £1,000;  a  day  or  two  be- 
fore the  four  months'  sight  draft  comes  due  in 
London  this  demand  draft  ("cover")  is  received 
in  London  from  New  York,  and  the  whole  opera- 
tion is  closed. 

It  has  been  deemed  advisable  to  set  forth  the 
whole  course  of  one  of  these  import-financing 
transactions,  in  order  that  each  successive  step 
may  be  clearly  understood.  The  question  of  just 
why  this  credit  business  is  worked  as  it  is  will  now 
be  taken  up. 

The  whole  purpose  of  the  business,  it  is  plain 
enough,  is  to  give  the  importer  here  a  chance  to 
bring  in  goods  without  putting  up  any  actual 
money — in  other  words,  of  letting  him  use  a 
larger  capital  than  he  is  actually  possessed  of. 
There  are  persons  so  conservative  as  to  consider 
this  in  itself  a  wrong  idea,  but  with  business  car- 
ried on  along  the  lines  on  which  it  is  actually  done 
nowadays,  bank  credits  play  so  important  a  part 
that  conservatism  of  this  order  has  little  place. 
Theory  and  practice  prove  that  there  is  no  reason 
why  a  silk  importer,  for  instance,  with  a  capital 


154  FOREIGN    EXCHANGE 

of  $100,000  should  not  be  able  to  use  safely  a 
credit  of  as  much  more  than  that,  the  standing 
and  credit  of  the  firm  being  always  the  prime  con- 
sideration. Granted  that  a  manufacturer  stands 
well  and  is  doing  a  safe,  non-speculative  business 
on  the  basis  of  $100,000  capital,  there  is  no  reason 
why  he  should  not  be  able  to  secure  an  import 
credit  for  an  additional  £20,000.  Not  only  is 
there  no  reason  why  he  should  not  get  it,  but 
there  are  any  number  of  good  banking  concerns 
only  too  glad  to  furnish  it  to  him. 

So  much  for  the  transaction  from  the  import- 
er's standpoint — what  does  the  seller  of  the  goods 
get  out  of  it?  Payment  for  his  goods  as  soon  as 
he  is  ready  to  ship  them.  No  waiting  for  a  remit- 
tance, no  drawing  of  a  dollar-draft  on  an  obscure 
firm  in  Paterson,  N.  J.,  which  no  Canton  bank 
will  be  willing  to  buy  at  any  price.  The  credit 
constitutes  authority  for  the  shipper  to  draw  in 
pounds  sterling  on  London — the  one  kind  of 
draft  which  he  can  always  be  sure  of  turning  at 
once  into  local  currency  and  at  the  most  favor- 
able rate  of  exchange.  He  ships  the  goods,  he 
draws  the  draft,  he  sells  the  draft,  he  has  his 
money,  and  he  is  out  of  it.  From  the  shipper's 
standpoint,  surely  a  most  satisfactory  arrange- 
ment and  one  which  will  induce  him  to  quote  the 
very  best  price  for  merchandise. 


FOREIGN    EXCHANGE  155 

As  to  the  banker's  part  in  the  transaction,  the 
whole  question  is  one  of  commission.  The  Lon- 
don banker  on  whom  the  credit  is  issued  gets  a 
commission  from  the  American  banker  for  "ac- 
cepting" the  drafts,  and  the  American  banker,  of 
course,  gets  a  substantial  commission  from  the 
party  to  whom  the  credit  is  issued.  Sometimes 
the  banker  in  New  York  and  the  banker  in  Lon- 
don work  on  joint-account,  in  which  case  both 
risk  and  commissions  are  equally  divided.  But 
more  often,  perhaps,  the  London  bank  gets  such- 
and-such  a  fixed  commission  for  accepting  drafts 
drawn  under  credits,  and  the  New  York  banker 
keeps  the  rest  of  what  he  makes  out  of  the 
importer. 

Before  proceeding  with  discussion  of  what 
commissions  amount  to,  it  is  well  to  note  the  fact 
that  in  those  commercial  credit  transactions 
neither  banker  is  ever  under  the  necessity  of  put- 
ting up  a  cent  of  actual  money.  As  in  the  case 
of  foreign  loans  previously  described,  the  bank- 
er's credit  and  the  banker's  credit  only  is  the  basis 
of  the  whole  operation.  The  London  bank  never 
pays  out  any  actual  cash — it  merely  "accepts"  a 
four  months'  sight  draft,  knowing  that  before  the 
draft  comes  due  and  is  presented  at  its  wicket 
for  payment,  "cover"  will  have  been  provided 


156  FOREIGN    EXCHANGE 

from  New  York.  The  New  York  banker,  on  the 
other  hand,  merely  sends  over  on  account  of  the 
maturing  draft  in  London  the  money  he  receives 
from  the  importer.  He  is  under  an  obligation  to 
the  London  banker  to  see  that  the  whole  £1,000 
is  paid  off  before  the  four  months  are  over,  but  he 
knows  the  party  to  whom  he  issued  the  credit, 
and  knows  that  before  that  time  all  the  silk  will 
have  been  manufactured  and  sold  and  the  pro- 
ceeds turned  over  to  him.  At  no  time  is  he  out 
of  any  actual  cash. 

That  being  the  case,  the  amount  of  commission 
he  charges  is  really  very  moderate — one-quarter 
of  one  per  cent,  for  each  thirty  days  of  the  life  of 
drafts  drawn  under  credits  being  the  "full  rate." 
Under  such  an  arrangement  an  importer  taking  a 
credit  stipulating  that  the  drafts  are  to  be  drawn 
at  thirty  days'  sight  would  have  to  pay  one-quar- 
ter of  one  per  cent. ;  at  sixty  days'  sight,  one-half 
of  one  per  cent. ;  at  ninety  days'  sight,  three-quar- 
ters of  one  per  cent.,  etc.  Such  commission  to  be 
collected  at  the  time  the  drafts  drawn  under  the 
credits  fall  due. 

These  are  the  "full  rates" — naturally,  few  im- 
porters are  required  to  pay  them,  actual  rates  be- 
ing largely  a  matter  of  individual  negotiation  and 
standing.     Where  the  drafts  under  the  credits 


FOREIGN    EXCHANGE  157 

run  for  ninety  clays,  for  instance,  as  in  the  case 
of  coffee  imported  from  Brazil,  the  full  rate 
would  be  three-quarters  of  one  per  cent.,  but  very 
few  firms  actually  pay  over  three-eighths  of  one 
per  cent.  Similarly  with  credits  issued  for  the 
importation  of  merchandise  of  almost  every  other 
kind.  Silk  credits,  with  drafts  running  four 
months,  ought  at  the  regular  rate  to  cost  one  per 
cent. ;  but  as  a  matter  of  fact  there  are  any  num- 
ber of  good  houses  willing  to  do  the  business  for 
five-eighths  of  one  per  cent.  One  large  interna- 
tional bank  in  New  York,  indeed,  is  going  so  far 
as  to  offer  to  issue  credits  under  which  drafts  run 
six  months  for  a  commission  of  five-eighths  of  one 
per  cent.  Such  a  commission  is  entirely  inade- 
quate and  no  fair  compensation  for  the  trouble 
and  risk  the  banker  takes.  It  means  little  more 
than  that  the  bank  is  willing  to  take  business  at 
any  price  for  advertising  or  other  purposes. 

Assume  that  an  importer  has  taken  out  a 
ninety-day  credit  and  is  to  pay  three-eighths  of 
one  per  cent,  on  all  drafts  drawn  thereunder, 
what  rate  of  interest  is  he  actually  paying,  figured 
on  an  annual  basis?  The  life  of  the  draft  is  ninety 
days,  and  he  pays  three-eighths  of  one  per  cent. ; 
in  each  year  there  are  four  ninety-day  periods; 
figured  on  an  annual  basis,  therefore,  the  im- 


158  FOREIGN    EXCHANGE 

porter  is  paying  four  multiplied  by  three-eighths 
of  one  per  cent.,  equalling  one  and  one-half  per 
cent,  interest.  Not  a  very  high  charge,  and  made 
possible  only  because  the  banker  lends  his  credit 
and  not  his  cash. 

For  purposes  of  illustration,  the  financing  of 
the  import  of  silk  from  China  was  chosen  be- 
cause the  operation  embodied  perhaps  more 
points  of  interest  in  connection  with  commercial 
credit  business  than  any  other  one  operation. 
Commercial  credit  operations,  however,  are  of 
great  variety  and  scope.  They  may  involve,  for 
instance,  the  import  of  matting  shipped  from 
Japan  on  slow  sailing  ships  and  where  the  drafts 
drawn  run  for  six  months  or  more,  or  they  may 
involve  the  import  of  dress  goods  from  France, 
in  which  case  the  drafts  are  often  at  sight.  Fur- 
thermore, all  credits  are  by  no  means  issued  on 
London.  In  the  Far  East,  where  tea  or  shellac 
or  silk  is  being  exported  to  the  United  States, 
London  is  known  as  the  one  great  commercial 
and  financial  center,  but  in  the  case  of  dress 
goods  shipped  from  Marseilles  or  Lyons,  for  in- 
stance, the  credits  would  invariably  stipulate  that 
the  drafts  be  drawn  in  francs  on  Paris. 

But  whether  the  material  imported  be  dress 
goods  from  France  or  tea  from  China,  the  prin- 


FOREIGN    EXCHANGE  159 

ciple  of  the  commercial  credits  under  which  the 
goods  are  brought  in  remains  identically  the  same. 
In  every  case  there  is  a  buyer  on  this  end  who 
wants  to  get  possession  of  the  goods  without  hav- 
ing to  put  up  any  money,  and  in  every  case  there 
is  a  seller  on  the  other  end  who  wants  to  receive 
payment  as  soon  as  he  lets  the  merchandise  get 
out  of  his  hands.  The  banker  issuing  the  credit 
is  merely  the  intermediary,  and  the  naming  of 
some  foreign  point  on  which  the  drafts  are  to  be 
drawn  is  merely  incidental  to  the  conduct  of  the 
operation. 

One  last  point  remains  to  be  cleared  up.  The 
seller  of  the  goods  in  the  silk-importing  operation 
described  gets  actual  money  for  the  goods  as  soon 
as  he  ships  them — where  does  this  actual  money 
come  from?  In  the  last  analysis,  from  the  dis- 
count market  in  London,  from  the  man  in  Lon- 
don who  discounts  the  draft  after  it  has  been  "ac- 
cepted". The  exporter  in  Canton  gets  the  money 
direct  from  his  banker  in  Canton,  but  the  latter  is 
willing  to  let  him  have  the  money  in  exchange  for 
the  draft  only  because  he  (the  banker)  knows 
that  he  can  send  the  draft  to  London  and  that 
some  one  there  will  eagerly  discount  it.  In  that 
way  the  Canton  banker  gets  his  money  back.  The 
only  party  who  is  out  of  any  money  during  the 


160  FOREIGN    EXCHANGE 

time  the  silk  is  being  manufactured  and  sold  in 
Paterson,  N.  J.,  is  the  party  in  London  who  has 
discounted  the  shipper's  draft. 

The  real  function  of  the  banker,  then,  in  these 
Commercial  Credit  transactions  is  to  open  up  the 
international  loaning  market  to  the  importer. 
Through  the  system  now  in  force  this  is  accom- 
plished by  a  banker  in  New  York  issuing  a 
credit  and  by  a  banker  in  London  putting  his 
"acceptance"  on  drafts  drawn  under  that  credit. 
The  combination  makes  the  drafts  good;  makes 
the  great  discount  market  in  London  willing  to 
take  them,  and  absorb  them,  and  advance  real 
money  on  them.  And  for  the  opening  up  of  this 
great  reservoir  of  capital  the  importer  here  has 
to  pay  an  interest  rate  of  but  from  one  to  two 
per  cent,  per  annum.  Naturally  the  business  has 
grown  to  tremendous  proportions. 


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